Chesbrough is Adjunct Professor, Haas School of Business at the University of California, Berkeley, and Executive Director of its Center for Open Innovation. His landmark book Open Innovation: The New Imperative for Creating and Profiting from Technology (2003) articulated a new paradigm for industrial research and development. His more recent book, Open Business Models: How to Thrive in the New Innovation Landscape (2006), carries the open approach a step further, arguing that business models themselves need to become more open.  Innovating business models requires open technology strategies, but also new approaches to managing intellectual property as well.  His most recent book, Open Services Innovation: Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era (2011), explores innovation in a services context.  He earned a BA degree in economics from Yale University, an MBA degree from Stanford University, and a PhD degree in business administration from UC Berkeley.

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Morris: Before discussing your latest book, Open Services Innovation, a few general questions. A great deal has happened in the global business world since our last conversation three years ago. In your opinion, which change during that recent period is the most significant and why do you think so?

Chesbrough: In the past three years, there has developed a short-term crisis in both the EU and the US, as each region wrestles with serious issues that are somewhat different.  But these issues have had a dampening effect on innovation in both regions, as companies manage through a turbulent and uncertain environment.  There is an unfortunate tendency to treat innovation as a luxury good, something to welcome in good times, but cut back on in tough times.

Meanwhile, there is a longer term and to my mind even more important trend, which is the rise of the “emerged markets”.  China, India and Brazil of course, but also Turkey, Latin American, South Africa, places that many innovation scholars gave little attention to in the past.  There is no question that in this rebalanced world innovation is going to become a global phenomenon to manage and to study.

Morris: As I survey the ever-increasing number of new technologies that appear, I am reminded of Goethe’s poem Der Zauberlehrling (The Sorcerer’s Apprentice) written in 1797. Do you share my concern that at least a few of the new disruptive technologies have taken on a life of their own?

Chesbrough: The statistic that blew me away the most was one I read on Henry Blodget’s Business Insider website.  It showed that people are spending fully half of their online time on the Net on Facebook, and the other half on everything else there is on the Web.  I don’t know if that’s true, but if so it is truly mind-blowing.  I know that it is not true of me or my wife, and that it is true of both of my daughters.  I don’t know what a world built around Facebook will look like in the future.  It makes me feel like I am on my way to becoming obsolete.

Morris: Howard Gardner’s extensive research on multiple intelligences suggests this next question: Can an “open” mindset be developed? If so, how?

Chesbrough: Yes I believe it can be developed.  While this is not an area that I have studied rigorously, I know from my own life experience that at the root of whatever open mindset I have is a basic humility that recognizes my own limitations and numerous areas of ignorance.  Being open for me means not being paralyzed by those shortcomings, but using my realization of them as a spur to learn and to grow. When I must function as an expert, ironically that often blocks my own growth.  When I get to ask questions, wonder why something is happening or how it works, I can feel myself being stretched ever so slightly in new directions.  Happily, being a teacher and having children both force me into stretching myself with some frequency!

Morris: In The Opposable Mind, Roger Martin has much of value to say about integrative thinking. As he explains, it is “the predisposition and the capacity to hold two [or more] diametrically opposed ideas” in one’s head at the same time and then “without panicking or simply settling for one alternative or the other,” be able to “produce a synthesis that is superior to either opposing idea.” Integrative thinking requires a “discipline of consideration and synthesis [that] is the hallmark of exceptional businesses and those who lead them.” This seems to describe the open mindset you have endorsed for years. Am I correct?

Chesbrough: Yes, you are.  I define open innovation to be a process whereby companies utilize external knowledge more extensively in their own innovation processes, and allow others to utilize the unused ideas they have outside.  Open innovation thinking is an “and”, not an “or”.  It is NOT an argument that calls for outsourcing all of one’s R&D.  Rather, it is a call to integrate internal and external in the integrative manner that Martin articulates.

Morris: What seem to be the most common – and troublesome – misconceptions about open innovation and open business models?

Chesbrough: Many conflate open innovation with open source software, or open source development methodologies.  While both concepts share an appreciation for open, participatory engagement of many people in the innovation process, open innovation explicitly incorporates the business model as a core part of the innovation process.  Many adherents in open source explicitly eschew business models as irrelevant or even evil.  Yet many observers of open source software itself would acknowledge that many businesses have built “open source business models” that helped them achieve greater impact and scale than they otherwise would have done.  To me, this is both a good thing (it is good that these open source tools and products have expanded greatly) and a statement of how the world works.  It also raises the possibility that adherents of open source sometimes overlook, that some business models could pervert the good intentions of open source and harness all that community contribution for nefarious purposes.  This was a concern when Microsoft tried to fork Java some years back by offering a version that only ran on Windows.  Oracle seems to be testing the waters lately with Java as they file suits against Google and others who utilize open source.

Morris: What, in fact, is true?

Chesbrough: Some of the most successful open source projects these days are led by large companies, who are investing significant time and effort into the open source projects because it directly or indirectly benefits their own business models (not because they have become altruistic).  Contributors and volunteers need to pay attention to who is driving the agenda for these projects, so that they remain aware of how their hard work is being used in the world.

Morris: Now please shift your attention to Open Services Innovation. When and why did you decide to write it?

Chesbrough: Well, I focused my previous books on innovating new products and new technologies.  But I often got questions about “what do I do if I am a service firm”?  I realized that we know a lot about how to innovate new products, new processes, and new technologies, but know far less about how to innovate in services.  Yet this is the majority of economic activity for most OECD countries.  So there was a gap to fill.  And there is good academic work going on in services innovation research, but little of that has been translated to a general audience.  That is part of what I tried to do in Open Services Innovation.

What gives this topic special importance is the rise of China and other emerging economies, those that are now innovating as well as manufacturing the innovations of others.  There is a risk of a commodity trap, where firms that focus exclusively on developing better products and technologies run the real risk of failing to differentiate their offerings sufficiently, and instead become commoditized by innovative entrants from the emerging parts of the world.

Morris: Were there any head-snapping revelations while writing the book?

Chesbrough: The biggest surprise to me was the realization that emerged during the writing process that even product-based companies should think about their businesses as services businesses.  I thought the focus of the book would be primarily upon innovation in banking, real estate, financial services, transportation and whatnot.  Instead, I learned through my research that many of the same companies I had studied in earlier work were getting more and more of their revenues from services.  And these companies were now wrestling with how to change their innovation process as their own businesses moved toward a combination of products and services.

Morris: For those who have not as yet read the book, you explain that four concepts and practices are critical to what you characterize as an “alternative approach or way of thinking that will enable innovation and growth.” Briefly, please explain the essence of each concept. You have already explained the first, “Think of your business as a services business, ”

The next is “Innovators must co-create with customers”

Chesbrough: Services are intangible.  They often are consumed as they are delivered.  This means that the customer often must be much more involved throughout the innovation process.  Co-creation implies a process in which the customer works quite closely with the provider in the innovation process.

Morris: Then, “Open innovation accelerates and deepens services innovation”

Chesbrough: Just as product-based innovation is becoming more open, openness is a powerful force in services innovation.  One of the most powerful benefits of openness is greater sharing of knowledge, leading to more focus and specialization.  Allowing others to access your platform, for example, can create powerful economies of scope, where your customers get more choices without you taking on all the additional complexity of supplying each of those choices.  And sharing your fixed investments with others can improve utilization and drive economies of scale.  This saves you money internally, because your fixed costs are spread over more volume, and it introduces additional revenues outside your main business.

Morris: Finally, “Business models are transformed by services innovation”

Chesbrough: Once you reconceptualize your business as a service business, you often have to transform your business model to exploit fully your new opportunities.  Many product companies, for example, bundle in some services for free in order to close the sale.  With a services focus, many of these formerly “free” services now have price tags.  The sales process shifts as well, from big, lumpy revenues received occasionally whenever the product is sold, to ongoing smaller revenue streams that last indefinitely.  Your metrics for running the business shift, from gross margin as a percentage of sales in a product company, to lifetime value of the customer, customer retention rates, and customer acquisition costs.

Morris: You point out that, in a services-driven view of business, “services are front and center” as a profit-making activity” and are used to differentiate the company from its competitors.” Please cite two or three example.

Chesbrough: I have taken care to supply lots of examples for my arguments throughout the book.  Xerox would be a good example here.   Instead of only selling copiers and printers, they are offering a service they call Managed Print Services, where you pay only for what you use, by the copy or by the page.  Xerox takes over all the management and maintenance of the equipment and keeps all the toner stocked, the paper in the machines and all the rest. It’s a very different way for its customers to obtain copies.  It’s a deceptively simple idea, but devilishly difficult to execute. Xerox takes responsibility for managing all the company’s copiers and printers, keeping them up and running and well maintained, charging the company only for the copies provided when they are provided.

It’s a terrific arrangement from the customer standpoint. Your competitive advantage is not in which copier do you buy; you want copying services, and you’re more than happy to have somebody take care of that for you, because if you yourself are running your own copiers in your own organization, that’s usually very much a backwater kind of job.  So the career paths at Xerox in Managed Print Services are far better than the career paths that Xerox’s customers can provide to people doing the same function.

It’s also beneficial for Xerox, for many of the reasons I go into in my book. One is that Xerox knows more about copiers and printers than even the most sophisticated of its customers. Its specialized knowledge allows it to manage resources more efficiently. Another is that Xerox can develop, install and operate the most efficient equipment over the life cycle of print services, which can generate big savings. Finally, Xerox manages all the customer’s print devices under these arrangements – not just those that it manufactures – so they it gets a better view of the customer’s overall copying and printing needs. This gives it a learning advantage over its competitors.

UPS has a similar offer in the package shipment business.  They have a program they offer to take over your shipping department, and BE the shipping dock for all packages, wherever they go.  Often, they will go out to FedEx or DHL or the Postal Service.  But UPS obtains a huge learning advantage from this, because they get visibility for the first time into the upstream processes at customers that are generating these shipments.  As a result, UPS has launched new offerings to help optimize supply chain logistics with many of its customers, because of this new knowledge they have acquired.

Morris: Of all the lessons that leaders in small companies can learn from the material in your book, which lessons do you think will be most valuable to them? Why?

Chesbrough: The commoditization trap hits small companies even harder than it hits the large ones.  So small companies need to keep moving, keep innovating, and keep hustling.  I have an entire chapter of the book devoted to small companies, with examples drawn from small companies to illustrate the points.  One great one is the Utilization Differential.  This is the idea that many fixed assets are poorly utilized, making them quite expensive relative to the function they perform.  Finding ways to utilize them more can save money and even bring in new revenues.  I write about a sailing club here in Berkeley that offered sailing classes.  Well it cost a lot of money to buy the boats to use in these classes.  They realized that many sailors who own their own boats don’t get to use them very often.  So they sold off their own boats, and now act as a booking agent for the boat owners, paying them to use the boat whenever they have a sailing class.  And the boat owners get a free slip and upkeep as a result of agreeing to participate in the program.  This is much more capital efficient, because the boats get used much more often.

Many small businesses have underutilized assets.  It may be their back office IT servers.  It may be their internal manufacturing facilities.  It could be their IP, or brand, or marketing channels.  These are important sources to unlock more profit and revenue.

Morris: Most change initiatives either fail or fall far short of expectations when they are launched. More often than not the strongest resistance is cultural in nature, the result of what James O’Toole so aptly characterizes in Leading Change as “the ideology of comfort and the tyranny of custom.” Here’s my question for you: How to avoid or overcome cultural resistance when establishing a services innovation business model?

Chesbrough: This is something I discuss at some length in the final chapter of the book.  First, it is a very difficult task to change an organization’s culture, so be prepared for that.  Second, if you are in a crisis, that can actually be a moment of opportunity to make these changes, because crisis often engenders a shared sense that the status quo is not working, and we do have to change.  Third, if you’re not in a crisis, then you need to start slowly, learn as you go, build your knowledge and (equally important) your credibility as someone who knows what they are doing.  You need to plan for small failures, because not everything will work successfully the first time.  If you don’t set expectations accordingly, a small setback could be used by skeptics to torpedo the entire initiative.

Morris: In your opinion, in which specific ways will open services innovation probably evolve during (let’s say) the next 3-5 years?

Chesbrough: Open innovation will move from bilateral innovation activities between a customer and a provider, say, to a more multilateral, community process for many early stages of innovation.  A number of companies are building innovation networks that clients can access to look for promising innovations.  Other companies are building tools to track and develop ideas throughout a company’s innovation process.  So I see a more collaborative, participatory future for open innovation, in both products AND services.

Morris: Which question had you hoped to be asked during this interview – but weren’t – and what is your response to it?

Chesbrough: This was an extensive set of questions that were a lot of fun to answer.  I hope the readers make it through the whole interview.   So I won’t add anything more here.

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If you wish to read the first interview, please click here.

Henry Chesbrough invites you to check out the wealth of resources at these websites

http://www.openinnovation.net/

http://openinnovation.berkeley.edu/

Twitter:  @OpenInno