Here is an excerpt from an interview of Henry Chesbrough by Rob Norton. It is the latest in The Thought Leader Interview Series featured by strategy+business magazine, published by Booz & Company. To read the complete interview, please click here.
[Photograph courtesy of Henry Chesbrough]
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To escape the commodity trap — and to compete effectively in a knowledge-based economy — business leaders of all kinds need to reinvent themselves as innovators in services.
Economists debate whether a service-based economy can be truly robust — or whether prosperity depends on having enough of a manufacturing base to support service businesses. But what if this turned out to be a false dichotomy? That’s the question raised by innovation expert Henry Chesbrough. All successful manufacturers, in Chesbrough’s view, need to come to terms with a fundamental change: the accelerating flows of knowledge and information that are shortening product cycles and commoditizing their products. They can do this, he says, only by reinventing themselves, not as pure manufacturers or service providers, but as hybrid product–service companies that design their business models around creating more meaningful experiences for their customers.
Of course, many manufacturers are already doing this. General Motors does it with its OnStar system; General Electric does it with its infrastructure financing; Ikea, Apple, Inditex (Zara), and many others do it with their own retail outlets; and Taiwan Semiconductor Manufacturing Company does it with its co-creation model for helping customers design computer chips, which it then manufactures to order. On the other side, service companies such as Barnes & Noble, Starbucks, and (most famously, with its Kindle) Amazon have found that they must enter the realm of manufacturing to thrive. Chesbrough goes one step further. He argues that successful product–service hybrids embrace a new kind of innovation, combining “open innovation” (moving outside the organization’s own boundaries) and services. Hence the title of his new book: Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era (Jossey-Bass, 2011).
Chesbrough, professor and executive director of the Program for Open Innovation at the Haas School of Business at the University of California at Berkeley, established himself as a leading voice with an earlier book, Open Innovation: The New Imperative for Creating and Profiting from Technology (Harvard Business School Press, 2003). He was the first major academic champion of the open innovation idea, which has made a great difference at Procter & Gamble, Unilever, and many other companies. Open innovation can be defined as revitalizing a company’s future by tearing down the walls between its R&D organization and outside companies and innovators. Chesbrough recalls that when he first considered the book title in 2003, he Googled the phrase and got only a couple of hundred links, most of them to articles on topics such as the opening of new innovation facilities. “There was no real usage of the term open innovation at that time,” he says. “When I did that same search last summer, I got 13 million responses, and most of them were really about this new model of innovation.”
Now Chesbrough argues that the fortunes of advanced companies — and of economies as a whole — will depend on how well they rethink services. His analysis began several years ago as he considered the fact that service-based industries were rapidly supplanting manufacturing-based industries — in developed economies in general, and in the U.S. economy in particular. Today, he points out, services account for roughly 60 percent of economic activity in the top 40 world economies, and fully 80 percent in the United States.
Services, in this context, doesn’t mean such small-scale activities as providing haircuts or washing cars — or even conventional large-scale services such as accounting and retail businesses. Instead, Chesbrough has a vision of knowledge-intensive infrastructure and product lines that evolve into “the engine of growth for the entire developed world.” Breaking out of the old manufacturing-based, product-centric mold, Chesbrough says, will be challenging for business leaders, because it requires them to think of their customers not as purchasers of goods, but as co-creating partners in an evolving relationship. Companies that master new service innovation models and build or add the requisite new capabilities, he promises, will be able “to reach levels of success they have never before experienced in their market or their industry.”
Chesbrough discussed the background and implications of his work with strategy+business at his office in Berkeley in February 2011.
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How did your idea of open services innovation evolve?
It began with thinking about the idea of the commodity trap. Richard D’Aveni at Dartmouth wrote an excellent book about the phenomenon [Beating the Commodity Trap: How to Maximize Your Competitive Position and Increase Your Pricing Power, Harvard Business Press, 2010]. He captures something important: the difficulty — given the globalization of manufacturing and, increasingly, the globalization of innovation itself — of sustaining a competitive advantage. If you are focused on making a better product that you drop in a box and ship, and it’s up to the customer to figure it out from there, I think you have a very, very hard time staying ahead of your competitors for very long in today’s environment. That was the motivation.
I trace the evolution of the cell phone in some detail in the book as one illustration. Commoditization is why Motorola had difficulties earlier on and Nokia is having them today. Today you have handsets coming from companies like HTC in Taiwan, and Samsung and LG in Korea, and many others, and you can imagine there will be handsets coming out of China and other places. Everybody understands how to do total quality management, enterprise resource planning, and all the methodologies of Six Sigma, so the things that let companies differentiate themselves and make better products have now become very widely distributed. It makes it harder and harder to sustain a good margin if you’re not simultaneously providing opportunities to wrap experiences around the products that you’re making. And these don’t have to be your own services, either; they can be others’.
If you look at the iPhone, iTunes, iPad — the whole “i” empire that Apple has built — they haven’t done it alone. They’ve done it with hundreds or thousands of apps makers alongside them, much as Microsoft did with Windows in the 1980s and ’90s, when they had, at one point, something like 75,000 independent software vendors working on Windows.
That’s the way products become platforms, and I think that’s where companies of all kinds need to end up, so that they’re not just making a product or a providing a simple service. The right way to think about it is, “How do I turn what I have into a platform?” And a platform, on the one hand, attracts others to build alongside and on top of what you’re doing, but on the other hand allows you to provide a much wider set of experiences. I go into some detail in the book about both the economies of scope and the economies of scale that a company can gain from being more open in services innovation. I think this is where you can continue to make money and escape that commodity trap.
In the early days of the Macintosh, Apple was famous for restricting innovation to a system it tightly controlled — and thereby limiting the market for its computers. What they’re doing now with the “iFamily” seems like quite a change.
The earlier history of Windows and the Mac is instructive. There were some lessons learned by Steve [Jobs] and others: that as good as you are, there are too many other smart people out there, and by cutting yourself off from them you really shoot yourself in the foot. But I don’t think they truly anticipated just how explosive the “iStore” apps sector was going to be, because really, there was nothing like it out there prior to this. To give Apple credit, they were able to keep up with the explosion. Their models opened up to accommodate the demand. By the time they launched the iPad in 2010, one of the things they were banking on was that because there were so many apps out there, the iPad could hit the ground running. And they were right; I think they sold 3 million units in the first 90 days after its introduction.
By doing that, they also put the new companies coming out with Android tablets and Android tablet apps at a disadvantage. We’re beginning to see a good library of Android apps become available, but even today it’s not as extensive as the Apple ecosystem. Although I’m sure the time is coming when it will fully catch up, and there will be wonderful stuff.
What are some other examples of how being open can provide scale and scope?
Amazon illustrates both. On the scope side, being open allows them to give more choices to customers. Amazon allows third-party merchants to use the same tools that Amazon uses to build their own Web pages; the third parties can build the Web pages on Amazon so that the user gets an exactly consistent experience, whether you’re buying books that Amazon sells or jewelry for which Amazon will take your money, but the actual merchandising and fulfillment is done by a third party.
The user gets a consistent experience; Amazon gets the money in advance, so they get that nice cash flow. And for the merchant, Amazon is one of the most heavily trafficked sites out there, so the merchants are going where the customers are. Amazon just had a great quarter in terms of revenues, and the third-party merchants’ revenues were up even more than Amazon’s own internally provided merchandise. Amazon is really benefiting from more of the customer’s share of wallet, so to speak.
On the scale side, Amazon is also interesting because it has to make huge investments to build the extensive server infrastructure to handle all the transactions. And Amazon has been criticized for a long time, especially by security analysts, who say, “Hey, you’re a retailer, why are you spending all this money on R&D and capital investment? When are you going to take your foot off the gas, and give it back to the shareholders?” And instead, Amazon has built this major server infrastructure, and created a new business called Amazon Web Services that hires out that infrastructure to other companies. You can have your website hosted by Amazon Web Services and you only pay for what you use. So if your business is not going well, you’re not getting a lot of traffic, you only pay Amazon a little. If your business starts to take off and you get a lot of traffic, you’ve got to pay Amazon more money — but your business is taking off, so you’ve got the money to pay. And you don’t have to put your own equipment in the ground, hire people to manage it, and all the rest. Amazon is world-class in managing that stuff, and the chances of you hiring people who are as good, and being able to keep that up at the level of availability that Amazon has, are for all but a handful of companies very low.
So companies like Barnes & Noble have essentially given up; they don’t even try to compete on these things. And the companies that compete with Amazon Web Services are those like Google and Microsoft and IBM and a very small number of companies that see these capabilities as fundamental to the cloud computing platform of the future. But Amazon got there long before others did, because they thought about their business much more broadly than as just being a focused online bookseller.
Being open allows you to get economies of specialization; that’s your path for gaining both economies of scope and economies of scale. If Amazon hadn’t been open either to the third-party merchants in the first case or to letting others use its infrastructure in the second case, it wouldn’t have gotten all this. Open services innovation is a key part of how Amazon makes all this possible.
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To read the complete interview, please click here.
Rob Norton is executive editor of strategy+business.