So welcome back to our course on Strategic Innovation.

I hope you're doing well today.

And today, this video

covers an increasingly important dimension of innovation, and that is,

innovation that extends across

firm boundaries instead of staying within the boundaries of the firm,

as we've pretty much talked about so far.

And so, this kind of cross-firm boundary approach,

encompasses many different forms of organization; alliances,

joint ventures, what's called open innovation,

user driven innovation and so on.

What we're going to do is, spend some time explaining why these approaches are appealing,

what advantages they might have.

But, I will also discuss some of the pitfalls,

some of the weaknesses,

how firms and their leaders can be successful with them and avoid those pitfalls.

So, what I want to do first is to discuss innovation across firm boundaries in general.

And I actually want to step outside innovation for a minute,

and to ask you to bring to

mind one of the fundamental choices that managers face in business.

And this is the make-or-buy decision, right?

Make, keep within the firm,

buy, outside the firm boundary.

Now, typically, when we talk about the make-or-buy decision,

we're not talking about it in an innovation context and typically we're talking about

gaining advantage on cost or flexibility and quality,

can enter into these discussions either as an advantage or a concern.

So,the thing that I want to make the link to is that,

this make-or-buy decision, exists where innovations are concerned as well.

But here, the key issues are a little bit different.

They tend to revolve around of course,

new technologies and changing markets.

And working with other firms,

offers the promise of greater responsiveness to those markets and technologies.

But we'll also see concerns arise about coordination,

information sharing and control and these can undercut those benefits.

So, the point is to recognize that,

this is just another version of the fundamental make-or-buy decision.

So, what does innovating across firm boundaries look like?

What are some ways that firms do this?

And so, I already ran through them a little bit but to go into a little more depth,

one very common way is joint ventures and alliances, and here,

firms are agreeing to cooperate with other firms often as a pair,

where they're sharing specific resources and setting

up some type of separate organization,

and there may even be shared equity as you see in joint ventures.

Another way, is through

contractual agreements with other firms that are acting as suppliers,

but the supplier and the central firm,

work more closely together than you'd typically expect.

They'll try to align their efforts to develop

new products and to capitalize on their joint capabilities.

And so, all of these approaches can be put under the heading of,

"virtual" approaches to organizing.

We might say that we're innovating through building a virtual firm,

where there's a number of independent firms that are acting as a coherent system,

an innovation system, in this case.

So, that's what we're trying to achieve.

Now, why would we choose this approach?

Well, two key reasons are typically cited,

and one of them revolves around resources.

Firms can pool their resources and capabilities,

and so access opportunities that would be relatively inaccessible for a single firm.

It might be that, there is a firm that has a strong position in

a particular market and another that's

developing a new technology and you put the two together,

and now you can move much more quickly to take advantage

of that technology market opportunity.

A second one, and this is one that I think, is the newer,

and I think the one that we need to think about carefully,

the newer one is,

greater ability to take risks when we use a virtual approach.

If we compare a product development team in an integrated firm,

and we've seen that, right?

And a team of similar people in a startup firm,

it's not hard to see that the people in the startup firm,

would have much stronger incentives,

equity, for one thing,

they could get rich off this project whereas,

in the integrated firm,

if the project succeeds,

your career is going to move forward but,

you're not going typically to get rich and in fact,

having been an entrepreneur,

I remember well that is not just the prospect of getting rich,

it's the prospect of survival that motivates you.

So, the independent firm,

a group of startups, so to speak,

is likely to be characterized by more efforts where people take risks,

move faster, work harder to succeed

in a new marketplace and the bottom line and in a new technology.

The bottom line is we can hope to gain superior responsiveness

to changing technologies and markets through a virtual approach,

a virtual system of firms.

That's the underlying idea.

And we can see this if we draw a chart, right,

where across the bottom,

we can array approaches,

in organizing from more integrated to more virtual.

So, at the left,

we would have the integrated firm,

and as we move across,

we'd see joint ventures and alliances where they are still structured quite extensively.

There are extensive discussions about how the firms are going to work together,

formalize an agreements, shared equity,

but then at the far right,

we have this fully virtual firm where there is a system,

an ecosystem, of independent firms so to speak.

And what we would see,

is if we drew the line that represents the capability to take risks,

we would see that increasing,

as we move from the integrated firm to the virtual system, right?

So, that sounds compelling,

but what might cause us to question this approach?

When would we want to stay?

Or why would we want to stay with the integrated firm?

And there are weaknesses to that virtual system, right?

They fundamentally revolve around some of the things we've talked about before,

that are very central to success in innovation,

and that's the ability where pursuing

different aspects of the opportunity to work together.

Right. People need to coordinate their efforts,

they need to share information,

and as we've become more virtual,

coordination often becomes more difficult because,

each firm tends to pursue its own self-interest.

Each follows its own agenda,

and these may not be aligned particularly over time.

It may be that at one time interests are aligned,

but then things change, right?

And recognizing this, players may be reluctant to

share information because they fear it will be used against them.

So, integrated firms, solve this problem through hierarchy, right?

You have a boss who adjudicates.

Culture, that gives us a common way of looking at things.

Teams, that have integrating mechanisms as we talked about earlier.

Now, these of course aren't perfect,

and they have their own drawbacks,

but they're a much stronger coordinating mechanism,

a much stronger way of sharing information than you would have with independent firms.

So, we could draw another line on this chart, right,

that shows that as you move from the virtual firms to the integrated firm,

you're going to see an increase in the ability to

coordinate and control efforts and to share information.

So, it's though, that trade-off, there's a trade-off,

that you're looking at when you're choosing these different forms of organization.

So, if we have a situation where there are trade-offs,

and where there are two dimensions to the advantages and disadvantages,

a natural question to ask in those situations is,

are there places where one approach is better than the other?

Are there innovation situations where in a virtual approach is the right one or not?

And to answer this question,

we have to distinguish between different types of innovations,

which we've done before,

but here the distinction that I'm going to make is a more

technical one than we have made in the past.

And it's between, autonomous innovations and systemic ones.

Now, Autonomous Innovations. What are these?

These are ones where the innovation can be independent of the others.

So to speak, it can be bolted on like a turbo charger for an auto engine or

a disk drive for a computer system that slips in and out of a slot on the computer.

The interface between different components,

when the autonomous innovation,

when you're in an autonomous situation,

is relatively standard and codified.

There is deep tacit information that needs to be shared, and so,

in these cases, the autonomous innovation can be developed on its own,

relatively speaking, there's less need for coordination and information sharing,

and so the virtual approach becomes more attractive

because its weakness is less important than its strength,

which is that you are going to build a great disk drive or

you are going to build a great turbo charger and that's all you're focused on,

and you're going to take risks in doing that.

That virtual approach becomes more attractive.

So, what about systemic innovations? What are these?

These are ones where the components are more interdependent.

You can't simply bolt the pieces on together and innovate one but not on the other.

So, with Polaroid and Instant photography,

both the new film and the camera that process that film

in a very particular way had to be developed.

Together, they fit like a glove,

and they were not separable.

And these are situations where integration has an edge.

You can anticipate there'll be a great need for sharing of sensitive information,

for coordination across different groups working on this innovation.

And it's going to be hard to get the commitment and

trust that's required to do this in a virtual system.

Whereas in the integrated system,

this is going to be playing to its strength.

Now, another factor that you think about besides

the autonomous or systemic distinction

when you're thinking about your innovation approach,

is control of the technological direction and the ability to

capture value from that as we move through time.

That the integrated firm is going to be the one that's

going to able to make decisions that connect these two ideas.

The direction of the technology,

how we're capturing value.

In a virtual system,

each firm is making,

each member of firm in that ecosystem or system is making them on its own.

And so an individual firm,

even the central firm,

may lose that control or the ability to capture value.

So, we can see these ideas on the two by two matrix.

You'd see the type of innovation across the top, right?

Autonomous and systemic. And on the side,

we distinguish between capabilities that already exist

and those that need to be created in that latter distinction,

exist or be created.

Speaks to where the control of the technology and

the ability to capture value is particularly important.

So, let's look at the top left and bottom right corners.

These are kind of the pure cases.

The top left is where we combine relatively independent innovations that already exist.

This is where there's a strong case for going

virtual because each firm can do its own thing.

The pieces are bolt together and in the end,

we'll gain value from our piece,

and the others will gain value from theirs,

and the system will move forward relatively quickly.

The bottom right, is the other pure case where

the innovation is systemic and the capabilities don't exist outside,

and so we have a strong case,

the coordination and control of the technology will both be

important so we should be thinking of an integrated approach there.

Now, the other two cells are

intermediate ones and the recommendation is intermediate as well.

And the top right, we've got the capabilities do exist.

We can go on ally with another firm to gain them but,

it's a systemic innovation.

So we still need to have a fairly high capability to coordinate and share information.

So we want to ally,

we want to ally carefully.

Bottom left, the innovation is autonomous

so we're not as concerned necessarily about coordination,

but control over time becomes important because this

is one where the capabilities still need to be created where the technologies developed.

So again, it is being developed so caution is advised.

You work on the less virtual side of the equation,

alliance or perhaps even keep that one in-house.

So what you have here is kind of a set of

framework for helping you to decide when you'd move more virtual,

when you'd move more integrated.

Let's take a look at an example that illustrates both the advantages of

a virtual system and what would be called an

open innovation architecture and the disadvantage.

And this is the IBM personal computer.

And we've already seen the history of personal computers.

Here, we're going to focus on this particular aspect of it.

So as you know,

IBM's initial launch was a great success,1981.

IBM quickly gained 41% market share by 1985.

And one of the reasons for that is that IBM built a virtual system,

they used a virtual approach.

They outsourced key major components in fact,

most major components notably,

the microprocessor through Intel,

and the operating system through Microsoft.

So the product hit the market fast, low investment,

very responsive to changing technology because

both Microsoft and Intel kept on innovating,

moving the processor and operating system forward.

And so it looks like it's a great success,

a real sign that the virtual approach can work.

The trouble is that we also see the downside here.

As you know, IBM isn't in the personal computer business anymore.

And the main reason is that they lost control of

the technology and thus their ability to capture value.

Competitors were able to duplicate IBM's assets,

their technology, and their distribution because the architecture was open.

They could go ahead and build something,

contract with Intel, contract with Microsoft,

build something quite similar.

And in fact, Microsoft and Intel in compact in different ways,

eroded IBM's position because

their contributions started to be as a more important than IBM's.

IBM recognized this, and in the late 80's tried to take control

back and to move to

a less virtual approach through introducing a different operating system,

a priotary operating system called OS/2.

But it turned out that IBM no longer had the power to

coordinate the network that it had itself created.

And OS/2 failed, Windows succeeded,

and thus we've can fast forward to today,

IBM market share declined to seven percent and then it sold the PC division.

So, that example illustrates

both the positives and the negatives of the virtual approach.

So in conclusion, what can we take away here?

And what you should remember is that to make the right choices in innovation situations,

you need to understand that a virtual approach has both strong advantages and weaknesses.

And the integrated approach has mirror image, strengths and weaknesses.

And you need to choose the approach that fits

the need of the innovation context that you face.

The distinction between autonomous and systemic innovation is important as is recognition

that this process developed over time and what

happens now will change once you create an ecosystem.

So thinking about control and capturing value over time is critical.

A key implication I think is,

and the point to really walk away from this with is that,

when you are going to be using a virtual approach,

you should probably not use it alone,

you should be using a hybrid approach in order to have staying power.

Right. Where you use the virtual model but

you are at the center of a network that you leverage,

that you use to leverage your own capabilities.

And I think if we look at Toyota or Nike,

we see that this is the approach that they've

used and it's a reason why they've been able to be successful over time.

Innovation Across Firm Boundaries: Virtual Firms & Open Innovation

Strategic Innovation: Managing Innovation Initiatives

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