Most innovations fail. And companies that don't innovate, die. This is a book about the process of innovation, how companies utilize and advance technologies to create new products and services. In today's world, where the only constant is change, the task of managing innovation is vital for companies of every size in every industry. It is vital to sustain and advance companies' current businesses; it is critical to growing new businesses. It is also a very difficult process to manage.

Innovation in the 21st Century: A Tale of Two Models

To paraphrase Charles Dickens, for innovation in this new century, it is "the best of times; it is the worst of times". Industrial technology is advancing our understanding of the natural world at an accelerating rate. In the oldest industry in the world, agriculture, companies are learning to use genetic and genomic technology to make crops more resistant to pests, to droughts, and diseases, even as they produce more output per acre. In another ancient industry, retailing, computing and communications advances are bringing retailers into closer contact with their customers, and enabling them to provide more variety with less inventory than ever before. The burgeoning services businesses all benefit from technologies that offer better communications with more capabilities at lower prices. The largest service industry, health care, is experiencing an explosion in our scientific understanding of the forces that create life, which offers the prospect of longer, healthier lives for us all.

Yet in many ways, it is the worst of times for innovating companies. Many leading companies are having a terrible time sustaining their internal R&D investments. Take the premier industrial research laboratory of the 20th century, Bell Labs. Not long ago, Bell Labs would have been a decisive strategic weapon in Lucent's battle with Cisco in the telecommunications equipment market.

Lucent, which was the telecommunications equipment company that was created in the breakup of AT&T, enjoyed significant momentum from its spin-off from AT&T in 1996, calling itself "the largest startup in history". It also inherited the lion's share of Bell Laboratories from the old AT&T, endowing it with a wealth of research and technology to focus on the telecommunications equipment market. And over the next five years, Lucent enjoyed many victories in the market with its new products. Yet Cisco consistently managed to keep up with them, and occasionally got to market ahead of them. While Bell Labs technologies did create many new products and services for Lucent, Cisco also seemed to introduce many new products and services, despite the fact that it lacked anything like the deep research capabilities of Bell Labs.

Though they were direct competitors in a very technologically complex industry, Lucent and Cisco were not innovating in the same manner. Lucent devoted enormous resources to exploring the world of new materials and state of the art components and systems, to come up with fundamental discoveries that could fuel future generations of products and services. Cisco, meanwhile, did practically no internal research of this type.

Instead, Cisco deployed a rather different weapon in the battle for innovation leadership. It scanned the world of startup companies that were springing up all around it, which were commercializing new products and services. Some of these startups, in turn, were founded by veterans of Lucent, or AT&T, or Nortel, who took the ideas they worked on at these companies, and attempted to build companies around them. Sometimes, Cisco would invest in these startups. Other times, it simply partnered with them. And more than occasionally, it would later acquire them. In this way, Cisco kept up with the R&D output of perhaps the finest industrial research organization in the world, without doing much internal research of its own.

Lucent's experience with the limits of its research capability is not unique. IBM's research prowess in computing was of no avail against Intel and Microsoft in the personal computer business. Similarly, Nokia has catapulted itself ahead of Motorola, Siemens, and other industrial titans to the forefront of wireless telephony in just twenty years, building on its industrial experience from earlier decades in the low tech industries of wood pulp and rubber boots. GE's labs are no longer the powerhouse they once were. Xerox has now formally separated from its famous Palo Alto Research Center. Hewlett-Packard's HP Labs has been broken up between HP and Agilent.

This leads to a number of paradoxes that confront all innovating companies in the early 21st century. While ideas abound, internal industrial research is less effective. While innovation is critical, the usual process of managing innovation doesn't seem to work anymore. While ideas and external capital are plentiful, companies struggle to find and finance internal growth opportunities. While industrial R&D spending is high, many worry that we are exhausting the "seed corn" of basic knowledge that will propel technology a generation from now.

Not long ago, internal research and development was viewed as a strategic asset, and even a barrier to competitive entry in many industries. Only large companies with significant resources and long term research programs could compete. Research-based companies like DuPont, Merck, IBM, GE, and AT&T did the most research in their respective industries. And they earned most of the profits as well. Rivals who sought to unseat these firms had to ante up their own resources, and create their own labs, if they were to have any chance against these leaders.

These days, the former leading industrial enterprises are finding remarkably strong competition from many newer companies. These newcomers conducted little or no basic research on their own: Intel, Microsoft, Sun, Oracle, Cisco, Genentech, Amgen, Genzyme. These companies have been very innovative, but they have innovated with the research discoveries of others. And there is a legion of other, even newer companies waiting to supplant these firms, if an opportunity should arise. These latter newcomers also are likely to rely on someone else's discoveries to ascend to leadership.

To make matters worse, some companies that made significant long term investments in research found that some of the resulting output, however brilliant, wasn't useful for them. They found ways to gracefully exit from further funding of these projects, and moved on to more promising work. Then, to their amazement, some of those abandoned projects later turned into very valuable companies. This was the experience of the Xerox Corporation, for example, with its Palo Alto Research Center. Numerous valuable computer hardware and software innovations were developed at PARC, but few of them made any money for Xerox and its shareholders.

A Shift in Innovation Paradigms

What accounts for the apparent decline in the innovation capabilities of so many leading companies, at a time when so many promising ideas abound? The research I have done in this book has led me to conclude that it is the way we innovate new ideas, and bring them to market, that is undergoing a fundamental change. In the words of the historian of science, Thomas Kuhn, I believe that we are witnessing a "paradigm shift", in how companies commercialize knowledge. The old paradigm is one I call "Closed Innovation". It is a view that says successful innovation requires control. Companies must generate their own ideas, and then develop them, build them, market them, distribute them, service them, finance them, and support them on their own. This paradigm counsels firms to be strongly self-reliant, because one cannot be sure of the quality, availability, and capability of others' ideas: "If you want something done right, you've got to do it yourself".

The logic that informed Closed Innovation thinking was an internally focused logic. This logic wasn't necessarily written down in any single place, but it was tacitly held to be self-evident as the "right way" to innovate. Here are some of the implicit rules of Closed Innovation:

--We should hire the best and the brightest people, so that the smartest people in our industry work for us.
--In order to bring new products and services to the market, we must discover and develop them ourselves.
--If we discover it ourselves, we will get it to market first.
--The company who gets an innovation to market first, will usually win.
--If you lead the industry in making investments in R&D, you will discover the best and most ideas, and will come to lead the market as well.
--We should control our IP, so that our competitors don't profit from our ideas.

This logic created a virtuous circle (figure I-1). Companies invest in internal R&D, which led to many breakthrough discoveries. These discoveries enabled those companies to bring new products and services to market, realize more sales and higher margins because of these products, and then reinvest in more internal R&D, which led to further breakthroughs. And because the intellectual property (IP) that arises from this internal R&D is closely guarded, others could not exploit these ideas for their own profit.

For most of the twentieth century, this paradigm worked, and worked well. The chemicals industry created the central research laboratory, and used it to identify and commercialize a tremendous variety of new products. Thomas Edison created an American version of this laboratory, used it to develop and perfect a number of important breakthroughs, and founded General Electric's famed laboratory. Bell Laboratories discovered amazing physical phenomena, and harnessed its discoveries to create the transistor, among its many important achievements. And the US government created an ad hoc central research laboratory to conduct a crash project on nuclear fission, which led to the development of the atomic bomb.

Figure I-2 depicts this Closed Innovation paradigm for managing R&D. The solid lines show the boundary of the firm. Ideas flow into the firm on the left, and flow out to the market on the right. They are screened and filtered during the research process, and the surviving ones are transferred into development, and then taken to market.

In Figure I-2 above, the linkage between research and development is tightly coupled and internally focused. Our extant theories of managing R&D are built upon this conception. Examples of this thinking are the "stage gate" process, the "chain link" model, and the product development funnel or pipeline found in most texts on managing R&D. Projects enter in on the left at the beginning, and proceed within the firm until they are shipped to customers on the right of the Figure. The process is designed to weed out false positives, projects that look initially appealing, but later turn out to be disappointing. The surviving projects, having survived a series of internal screens, hopefully have a greater chance of success in the market.

*Endnotes were omitted

Copyright 2003 Henry Chesbrough