Chapter 13 Harnessing the Engine of Global Innovation

History and Importance

From Edison’s lab onward, companies learned that a systematic approach to research could provide big competitive advantages. Companies could not only invent new products, but they could also turn those inventions into innovations that launched whole new industries. For example, the radio, wireless communications, and television industry grew out of early-twentieth-century research by General Electric and American Telephone and Telegraph (AT&T, which founded Bell Labs).

The heyday of American R&D labs came in the 1950s and early 1960s, with corporate institutions like Bell Labs, RCA labs, IBM’s research centers, and government institutions such as NASA and DARPA. These labs funded both basic and applied research, giving birth to the transistor, long-distance TV transmission, photovoltaic solar cells, the UNIX operating system, and cellular telephony, each of which led to the creation of not just hundreds of products but whole industries and millions of jobs.Adrian Slywotzky, “How Science Can Create Millions of New Jobs,” BusinessWeek, September 7, 2009, accessed May 11, 2011, http://www.businessweek.com/magazine/content/09_36/b4145036678131.htm. DARPA’s creation of the Internet (known at its inception as ARPAnet) and Xerox PARC’s Ethernet and graphical-user interface (GUI) laid the foundations for the PC revolution.Adrian Slywotzky, “How Science Can Create Millions of New Jobs,” BusinessWeek, September 7, 2009, accessed May 11, 2011, http://www.businessweek.com/magazine/content/09_36/b4145036678131.htm.

© 2011 IBM Corporation

Companies invest in R&D to gain a pipeline of new products. For a high-tech company like Apple, it means coming up with new types of products (e.g., the iPad) as well as newer and better versions of its existing computers and iPhones. For a pharmaceutical company, it means coming out with new drugs to treat diseases. Different parts of the world have different diseases or different forms of known diseases. For example, diabetes in China has a different molecular structure than diabetes elsewhere in the world, and pharmaceutical company Eli Lilly’s new R&D center in Shanghai will focus on this disease variant.“2011 Global R&D Funding Forecast,” R&D Magazine, December 2010, accessed February 27, 2011, http://www.battelle.org/aboutus/rd/2011.pdf. Even companies that sell only services benefit from innovation and developing new services. For example, MasterCard Global Service started providing customers with emergency cash advances, directions to nearby ATMs, and emergency card replacements.Lance Bettencourt, Service Innovation (New York: McGraw-Hill, 2010), 99.

Innovation also includes new product and service combinations. For example, heavy-equipment manufacturer John Deere created a product and service combination by equipping a GPS into one of its tractors. The GPS keeps the tractor on a parallel path, even under hands-free operation, and keeps the tractor with only a two-centimeter overlap of those parallel lines. This innovation helps a farmer increase the yield of the field and complete passes over the field in the tractor more quickly. The innovation also helps reduce fuel, seed, and chemical costs because there is little overlap and waste of the successive parallel passes.Lance Bettencourt, Service Innovation (New York: McGraw-Hill, 2010), 110.

Not only do companies benefit from investing in R&D, but the nation’s economy benefits as well, as Massachusetts Institute of Technology (MIT) professor Robert Solow discovered. Solow showed mathematically that, in the long run, growth in gross national product per worker is due more to technological progress than to mere capital investment. Solow won a Nobel Prize for his research, and investment in corporate R&D labs grew.

Although R&D has its roots in national interests, it has become globalized. Most US and European Fortune 1000 companies have R&D centers in Asia.“2011 Global R&D Funding Forecast,” R&D Magazine, December 2010, accessed February 27, 2011, http://www.battelle.org/aboutus/rd/2011.pdf. You’ll see the reasons for the globalization of R&D in Section 13.3 "How to Organize and Where to Locate Research and Development Activities".

The Role of Government

Governments have played a large role in the inception of R&D, mainly to fund research for military applications for war efforts. Today, governments still play a big role in innovation because of their ability to fund R&D. A government can fund R&D directly, by offering grants to universities and research centers or by offering contracts to corporations for performing research in a specific area.

Governments can also provide tax incentives for companies that invest in R&D. Countries vary in the tax incentives that they give to corporations that invest in R&D. By giving corporations a tax credit when they invest in R&D, governments encourage corporations to invest in R&D in their countries. For example, Australia gave a 125 percent tax deduction for R&D expenses. The Australian government’s website noted, “It’s little surprise then, that many companies from around the world are choosing to locate their R&D facilities in Australia.” The government also pointed out that “50 percent of the most innovative companies in Australia are foreign-based.”Committee on Prospering in the Global Economy of the 21st Century (U.S.), Committee on Science, Engineering, and Public Policy (U.S.), Rising Above the Gathering Storm (Washington, DC: National Academies Press, 2007), 195.

Finally, governments can promote innovation through investments in infrastructure that will support new technology and by committing to buy the new technology. China is doing this in a big way, and it is thus influencing the course of many companies around the world. Since 2000, China has had a policy in place “to encourage tech transfer from abroad and to force foreign companies to transfer their R&D operations to China in exchange for access to China’s large volume markets,” reported R&D Magazine in its 2010 review of global R&D.“2011 Global R&D Funding Forecast,” R&D Magazine, December 2010, accessed February 27, 2011, http://www.battelle.org/aboutus/rd/2011.pdf. For example, any automobile manufacturer that wants to sell cars in China must enter into a partnership with a Chinese company. As a result, General Motors (GM), Daimler, Hyundai, Volkswagen (VW), and Toyota have all formed joint ventures with Chinese companies. General Motors and Volkswagen, for example, have both formed joint ventures with the Chinese company Shanghai Automotive Industry Corporation (SAIC), even though SAIC also sells cars under its own brand.Brian Dumaine, “China Charges into Electric Cars,” Fortune, November 1, 2010, 140. The Chinese government made another strategic decision influencing innovation in the automobile industry. Because no Chinese company is a leader in internal combustion engines, the government decided to leapfrog the technology and focus on becoming a leader in electric cars.Bill Russo, Tao Ke, Edward Tse, and Bill Peng, China’s Next Revolution: Transforming The Global Auto Industry, Booz & Company report, 2010, accessed February 27, 2011, http://www.booz.com/media/file/China’s_Next_Revolution_en.pdf. “Beijing has pledged that it will do whatever it takes to help the Chinese car industry take the lead in electric vehicles,” notes industry watcher Brian Dumaine. Brian Dumaine, “China Charges into Electric Cars,” Fortune, November 1, 2010, 140. That includes allocating $8 billion in R&D funds as well as another $10 billion in infrastructure (e.g., installing charging stations).Gordon Orr, “Unleashing Innovation in China,” McKinsey Quarterly, January 2011, accessed January 2, 2011, https://www.mckinseyquarterly.com/Strategy/Innovation/Unleashing_innovation_in_China_2725. The government will also subsidize the purchase of electric cars by consumers and has committed to buying electric cars for government fleets, thus guaranteeing that there will be buyers for the new electric vehicles that companies invent and develop.

Another role of government is to set high targets that require innovation. In the 1960s, the US Apollo space program launched by President John F. Kennedy inspired US corporations to work toward putting a man on the moon. The government’s investments in the Apollo program sped up the development of computer and communications technology and also led to innovations in fuel cells, water purification, freeze-drying food, and digital image processing now used in medical products for CAT scans and MRIs.Adrian Slywotzky, “How Science Can Create Millions of New Jobs,” BusinessWeek, September 7, 2009, accessed May 11, 2011, http://www.businessweek.com/magazine/content/09_36/b4145036678131.htm. Today, government policies coming from the European Union mandate ambitious environmental targets, such as carbon-neutral fuels and energy, which are driving global R&D to achieve environmental goals the way the Apollo program drove R&D in the 1960s.Martin Grueber and Tim Studt, “A Battelle Perspective on Investing in International R&D,” R&D Magazine, December 22, 2009, http://www.rdmag.com/Featured-Articles/2009/12/Global-Funding-Forecast-A-Battelle-Perspective-International-R-D.

After the 1990s, US investment in R&D declined, especially in basic research. Governments in other countries, however, continue to invest. New government-corporate partnerships are developing around the world. IBM, which for years closely guarded its R&D labs (even IBM employees were required to have special badges to enter the R&D area), is now setting up “collaboratories” around the world. These collaboratories are partnerships between IBM researchers and outside experts from government, universities, and even other companies. “The world is our lab now,” says John E. Kelly III, director of IBM Research.Steve Hamm, “How Big Blue Is Forging Cutting-edge Partnerships around the World,” BusinessWeek, August 27, 2009, accessed January 2, 2010, http://www.businessweek.com/print/magazine/content/09_36/b4145040683083.htm. IBM has deals for six future collaboratories in China, Ireland, Taiwan, Switzerland, India, and Saudi Arabia.

The reason for the collaboratory strategy is to share R&D costs—IBM’s partners must share 50 percent of the funding costs, which means that together the partners can participate in a large-scale effort that they’d be hard pressed to fund on their own. An example is IBM’s research partnership with the state-funded Swiss university ETH Zurich. The two are building a $70 million semiconductor lab for nanotech research with the goal of identifying a replacement for the current semiconductor-switch technology.Steve Hamm, “How Big Blue Is Forging Cutting-Edge Partnerships around the World,” BusinessWeek, August 27, 2009, accessed January 2, 2010, http://www.businessweek.com/print/magazine/content/09_36/b4145040683083.htm. Such a breakthrough could harken the creation of a whole new industry.

Governments can also play a big role in the protection of intellectual property rights, as you’ll see in Section 13.2 "Intellectual Property Rights around the Globe".

Intellectual Property Rights

For companies to gain financial benefits from investing in research and coming up with new inventions, there must be legal protection for those inventions. The system of law related to R&D and innovation is referred to as intellectual property rights. Different countries vary in the extent to which they protect intellectual property and enforce intellectual property regulations. The presence of strong, enforceable, consistent property rights serves to make the world flatter. However, as long as significant differences in property rights exist around the globe, the world will be far from flat with respect to innovation.

Intellectual property (IP)Creations of the mind, such as inventions, literary and artistic works, and symbols, names, and images used in commerce. refers to creations of the mind—inventions, literary and artistic works, and symbols, names, and images used in commerce.“What Is Intellectual Property?,” World Intellectual Property Organization, 2003, accessed March 4, 2011, http://www.wipo.int/freepublications/en/intproperty/450/wipo_pub_450.pdf. The term property connotes ownership that’s exclusive, but the owners have the right to license or sell their IP. Under intellectual property law, owners are granted certain exclusive rights—intellectual property rights (IPR)The exclusive rights granted to owners for their intangible assets under intellectual property law.—to the discoveries, inventions, words, phrases, symbols, and designs they create.

Let’s look at the ways companies protect their IP and profit from it. The simplest way for a company to protect its intellectual property is to never reveal it—to create what is called a trade secretAny confidential business information which provides an enterprise with a competitive edge.. This is how Coca-Cola protects the formula for its hugely popular soda. If the secret were discovered or revealed through nefarious intent, then trade secret law would allow punishment of the perpetrator, including criminal prosecution. But if a company somehow developed the same formula on its own, Coca-Cola could do nothing to stop them. Therefore, companies opt for other IP protection—namely, patentsExclusive right granted for an invention, whether a product or a process, which must be industrially applicable (useful), be new (novel), and exhibit a sufficient “inventive step” (be nonobvious). and copyrightsThe body of laws that grants authors, artists, and other creators protection for their literary and artistic creations, which are generally referred to as “works.”.

The most common way to protect an industrial discovery or invention is to patent it. A patent is an inventor’s exclusive right granted by the government for an invention, whether a product or a process, that is industrially applicable (i.e., useful) or new (i.e., novel) or exhibits a sufficient “inventive step” (i.e., be nonobvious) To get a patent, the company must reveal the details of the invention. The rationale for revealing the invention details is so that others can build on the invention and thus promote further innovation. By revealing the invention, companies obtain legal protection and the right to exclusive sales of the invention (or the right to license or sell its use to others). The patent gives the patent owner a monopoly on the invention for a specific number of years.

Patents can be granted within a single country or internationally. Christian Hahner, head of Intellectual Property & Technology Management at Daimler, said, “Attaining international patent protection is an expensive undertaking. If we believe it’s important for our business to actively defend our patent in court in order to prevent unauthorized copies or imitations, then we have to nationalize the patent, which makes it valid in other countries.”Peter Thomas, “Patents Are the Future of Innovation Management,” Technicity, 2010, accessed February 10, 2011, http://www.daimler-technicity.de/en/christianhahner. A patent prohibits other people from selling the identical product built in the same way as the accepted patent. Patents give the owner the right to defend the invention in court, but they don’t automatically mean that the owner will win the court case.

“When I make an innovation public in Germany by initially registering a patent, I’m actually defining the state of the art. It then becomes impossible for anyone else in the world to patent that innovation,” Hahner said. “The publication of the patent also creates conditions that enable the worldwide utilization of innovations with great value to society—like those related to vehicle safety, for example.”Peter Thomas, “Patents Are the Future of Innovation Management.” Technicity, 2010, accessed February 10, 2011, http://www.daimler-technicity.de/en/christianhahner. That is, by disclosing the invention publicly, the inventor gets legal protection from outright copying of the invention, but society also benefits because others learn about the invention and can try to devise a different, original way to achieve the same outcome. Because of this fear of copying, some companies, such as Microsoft, choose not to patent some of their products. For example, Microsoft does not have a patent on its Windows software because doing so would force it to reveal its source code, which Microsoft does not want to do.

A trademarkA distinctive sign, which identifies certain goods or services as those produced or provided by a specific person or enterprise. is a distinctive sign that identifies certain goods or services as those produced or provided by a specific person or enterprise. A trademark uniquely identifies the source of the product. Companies trademark brand names and then advertise to build familiarity with that name.Steve Steinhilber, Strategic Alliances (Cambridge, MA: Harvard Business School Press, 2008), 98. Consumers come to trust the name and look for other products by that maker.

For a brief review of the main types of intellectual property rights, see Table 13.1 "Intellectual Property Types", which is reprinted with permission from Exchanging Value—Negotiating Technology Licensing Agreements—A Training Manual, which was published jointly by the World Intellectual Property Organization (WIPO) and the International Trade Centre (ITC) (http://www.wipo.int/sme/en/documents/pdf/technology_licensing.pdf).

Licensing IP Rights

The word license, according to the World Intellectual Property Organization (WIPO), means permission granted by the owner of the intellectual property to another to use it according to agreed terms and conditions, for a defined purpose, in a defined territory, and for an agreed period of time.Geoffrey Loades, “Exchanging Value: Negotiating Technology Licensing Agreements,” World Intellectual Property Organization, 2005, 14. In licensingThe owner of an asset granting the right to use the asset to another while continuing to retain ownership of the asset; an important way of creating value with assets. IP rights, the IP owner gives permission to use the IP but retains ownership of the IP.

Some companies obtain patents mainly to license or sell them to others, thus making money from their inventions without having to manufacture or service anything themselves. In turn, other companies actively seek patents that they can purchase because they want to speed up their own R&D efforts. For example, even Daimler, which registered 2,000 patents in 2009, pays 2,600 outside inventors to use their innovations in Daimler products.Peter Thomas, “Patents Are the Future of Innovation Management,” Technicity, 2010, accessed February 10, 2011, http://www.daimler-technicity.de/en/christianhahner. Filing patents is relatively inexpensive; even entrepreneurs can afford the filing fee. But defending a patent can be expensive. Given how overworked the patent examiners are, they often err on the side of granting a patent, which means that there are often overlapping patents. “We wind up in these fights over patents where we can’t tell what they mean, and the courts can’t tell what they mean, and even the patentees can’t tell you what they mean,” said David Kappos, a lawyer who managed IBM’s patent portfolio.Jeff Howe, Crowdsourcing (New York: Three Rivers Press, 2008), 65.

IP Protection Varies by Country

The US government’s Office of the United States Trade Representative (USTR) monitors intellectual property rights around the world and fights IP theft because IP theft impacts the 18 million Americans whose livelihood depends on IP protection.United States Trade Representative, “USTR Releases 2010 Special 301 Report on Intellectual Property Rights,” press release, April 2010, accessed February 27, 2011, http://www.ustr.gov/about-us/press-office/press-releases/2010/april/ustr-releases-2010-special-301-report-intellectual-p. The USTR evaluates countries and rates them according to how those countries enforce IP rights. The Special 301 Report is an annual review of the global state of IPR protection and enforcement issued by the USTR. The worst offenders are put on a “Priority Watch List.” The countries on the 2010 Priority Watch list are China, Russia, Algeria, Argentina, Canada, Chile, India, Indonesia, Pakistan, Thailand, and Venezuela. China, which has been on the Watch List before, continues to be on the list not only because of IP theft and counterfeiting but also because of government practices that severely restrict the market for foreign goods while giving favored treatment to “indigenous innovation.”United States Trade Representative, “USTR Releases 2010 Special 301 Report on Intellectual Property Rights,” press release, April 2010, accessed February 27, 2011, http://www.ustr.gov/about-us/press-office/press-releases/2010/april/ustr-releases-2010-special-301-report-intellectual-p. Countries can get off the Watch List by taking measures to reduce IP theft. The Czech Republic, Hungary, and Poland were all removed from the Watch List because they took significant steps to clamp down on piracy and counterfeiting.

WIPO

The World Intellectual Property Organization (WIPO)The global nongovernmental organization tasked with coordinating and marshalling efforts to harmonize intellectual property rights among countries and regions. is a specialized agency of the United Nations that works to harmonize the intellectual property laws of countries around the world. Although the roots of the WIPO go back to 1883, WIPO became an agency of the United Nations in 1974, with a mandate to administer intellectual property matters recognized by the member states of the UN. In 1996, WIPO expanded its role and further demonstrated the importance of intellectual property rights in the management of globalized trade by entering into a cooperation agreement with the World Trade Organization (WTO). Today, WIPO seeks to

• harmonize national intellectual property legislation and procedures,
• provide services for international applications for industrial property rights,
• exchange intellectual property information,
• provide legal and technical assistance to developing and other countries,
• facilitate the resolution of private intellectual property disputes, and
• marshal information technology as a tool for storing, accessing, and using valuable intellectual property information.“WIPO Treaties—General Information,” World Intellectual Property Organization, accessed November 22, 2010, http://www.wipo.int/treaties/en/general.

How to Organize R&D Activities

The flattening world is putting more pressure on corporate research and development (R&D) to come up with new products and services in less time and at lower cost. As a result, new models for how a company should organize its R&D activities have emerged. The traditional model of having one central R&D center located in the United States is being replaced by having a network of smaller R&D centers located in various parts of the world. The reasons for this dispersion of R&D activities are to tap talent around the world, to lower costs, and to be better able to develop new products and services tailored to new country markets.

When designing the R&D network, companies need to make sure that all centers use the same communication and information systems platform so that team members can communicate regardless of where they are. Some companies also offer financial and promotion incentives to encourage employees to work in different locations.Thomas Goldbrunner, Yves Doz, and Keeley Wilson, “The Well-Designed Global R&D Network,” Strategy and Business, May 30, 2006, accessed January 2, 2011, http://www.strategy-business.com/article/06217?gko=0a6cc.

The director of HP Labs, Prith Banerjee, explains the benefit and rationale for locating R&D activities in new-market countries in order to innovate more effectively for those markets. Today, HP Labs is located in seven different regions around the world, including India, China, Russia, and Israel. One reason for being in India, besides lower labor costs, is to tap the talent in India and their knowledge of local needs.

Source: HP

The mission of HP Labs India, Banerjee says, is innovation for the next billion customers: “I strongly believe that it is not very easy for researchers sitting in Palo Alto to imagine the problems for the billion people in India, the vegetable vendors in India. What kind of cell phones, what kind of PDA devices would they need to solve their day-to-day problems? Sitting here in Palo Alto, you imagine that the whole world is developed, and it’s not. So the researchers in India are actually working on precisely those problems.”“Wedding Innovation with Business Value: An Interview with the Director of HP Labs Prith Banerjee,” McKinsey Quarterly, February 1, 2010, accessed January 2, 2011, https://www.mckinseyquarterly.com/Strategy/Innovation/Wedding_innovation_with_business_value_An_interview_with_the_director _of_HP_Labs_2522.

One of the challenges of a distributed global network of R&D centers is managing employees located in different countries. Booz & Company surveyed R&D leaders in 186 companies in nineteen nations to ask them their most pressing R&D challenges. The three top challenges executives listed were (1) how to assess the value of a new idea, (2) how to encourage collaboration across geographical locations and functions, and (3) managing the complexity of global R&D projects.Thomas Goldbrunner, Yves Doz, and Keeley Wilson, “The Well-Designed Global R&D Network,” Strategy and Business, May 30, 2006, accessed January 10, 2011, http://www.strategy-business.com/article/06217?gko=0a6cc. One way that large multinationals manage the challenge of globally distributed innovation activities is through specially trained innovation teams. For example, Whirlpool has devised a way to help encourage and share innovation across a globally distributed enterprise. Specifically, Whirlpool designates “i-mentors” and trains them in innovation and deploys them throughout the organization to identify promising new product ideas.Jessie Scanlon, “How Whirlpool Puts New Ideas through the Wringer,” BusinessWeek, August 3, 2009, accessed January 17, 2011, http://www.businessweek.com/innovate/content/aug2009/id2009083_452757.htm. Similarly, General Mills has two “innovation squads” to harvest ideas from outside and inside the company, respectively. The cross-functional squads consist of six to eight company veterans with between fifteen and twenty-five years of experience. These people hunt for good business ideas and present them to division heads. The squads also give their top-ten ideas to the company chairman once a quarter. For example, one squad found a patent that had been donated to a university. The patent pertained to a new method for encapsulating calcium. The squad converted it into a very successful new product line of orange juice with added calcium that doesn’t taste chalky.Peter Erickson, “Innovating on Innovation” (keynote presentation at the Front End of Innovation Conference, Boston, MA, May 2009); MIT Center for Transportation and Logistics, “Future Capabilities in the Supply Chain” (presentation in Cambridge, MA, May 8, 2007).

Deciding Where to Locate R&D Activities

As we saw in the above example, HP is locating R&D labs in the countries for which it wants to develop new products. Another strategy is to locate the R&D center in a location known to be an innovation hub.

The concept of an innovation hubA geographic region that contains a cluster of company R&D centers, universities, and government research institutes in close proximity. is based on Harvard Business School Professor Michael Porter’s concept of clusters, which he defined in his book The Competitive Advantage of Nations. A cluster is defined as “a geographic concentration of business initiatives, suppliers and associated institutions in a particular field.”Juan A. Bertolin, “Convoy Model: The Dynamic Perspective of Porter’s Cluster Model,” Innovation Management, December 8, 2010, accessed March 10, 2011, http://www.innovationmanagement.se/2010/12/08/convoy-model-the-dynamic-perspective-of-porters-cluster-model. This particular model of location advantage is summarized in Figure 13.1 "Determinants of Location Advantages". For example, Silicon Valley in California is a cluster for technology companies that have located (or were founded) there. The partnerships and cross-pollination of ideas among the companies created new high-tech businesses whose success in turn brought venture capitalists (VCs) there. VCs looked for new ideas to fund, which led to more high-tech start-ups, thus stimulating even further innovation and new business creation.

Figure 13.1 Determinants of Location Advantages

Adapted from Porter, 1990

Strategy consulting firm McKinsey & Company partnered with the World Economic Forum to evaluate what makes a given region an innovation hub. McKinsey analyzed 700 variables, including business environment, government and regulation, human capital, infrastructure, and local demand.André Andonian, Christoph Loos, and Luiz Pires, “Building an Innovation Nation,” McKinsey & Company: What Matters, March 4, 2009, accessed February 24, 2011, http://whatmatters.mckinseydigital.com/innovation/building-an-innovation-nation. An innovation hub includes universities, government research institutes or labs, and corporate R&D centers. The purpose of the collocation is to create a dense social network. Geographic proximity promotes repeated interactions among people and thus builds trust among the people; companies compete intensely with each other but at the same time they learn from each other about changing markets and technologies.AnnaLee Saxenian, Regional Advantage (Cambridge, MA: Harvard University Press, 1994), 2–3, 161.

Innovation hubs usually have a specific industry focus, which can be anything from footwear to technology to life sciences. Let’s take a look at examples that make this concept clearer. Zhongguancun is a technology district in northwestern Beijing known as “the Silicon Valley of China.”Steve Todd, Innovate with Global Influence (Bangor, ME: Booklocker.com, 2010), 9. Within a one-mile area are China’s top two universities, Tsinghua University and Peking University. Also in the area is Tsinghua Science Park and Shanghai Science and Technology Center. American high-tech company EMC located an R&D facility in this area to be in close proximity to the university talent and encourage some of them to work for EMC. EMC located another R&D center in Bangalore, India, in the Marathahalli-area innovation hub that’s home to the R&D centers of IBM, Oracle, HP, Cisco, and Google; it is also home to the India Institute of Management, a university ranked among the top business schools in the world. Cisco’s R&D center in Bangalore has 1,400 employees, and Cisco invested $750 million in R&D in India.“The New Geography of Global Innovation,” Innovation Management, September 20, 2010, accessed February 26, 2011, http://www.innovationmanagement.se/wp-content/uploads/2010/10/The-new-geography-of-global-innovation.pdf. Illustrating Banerjee’s point, however, is that despite all the high-tech companies in the Bangalore area, employees still have to stop their cars for cattle crossing the highway.Steve Todd, Innovate with Global Influence (Bangor, ME: Booklocker.com, 2010), 13.

The single common factor that drives innovation across all sectors is the availability of a well-qualified talent pool. Talent attracts talent, creating a reinforcing success cycle. People go to work where the work is exciting. If one location has a concentration of R&D labs, universities, and government research facilities, high-caliber people will be attracted to that location.

Hubs are known for the cross-pollination of ideas that takes place when employees of one firm talk with employees of another simply because of their proximity and frequenting the same local restaurants, events, or transportation stops. A specific phenomenon that occurs with this proximity is knowledge spilloverAn informal exchange of ideas among individuals that helps individuals understand the state of the art in their field.. That is, knowledge can “spill over” as locals talk with one another; through those conversations, employees are more likely to understand each other’s innovations and build on them. For example, Adam Jaffe and his colleagues analyzed the prior patents that a firm cited when applying for a new patent.Adam Jaffe, Manuel Trajtenberg, and Rebecca Henderson, “Geographic Localization of Knowledge Spillovers as Evidenced by Patent Citations,” Quarterly Journal of Economics 108, no. 3: 577–98. Jaffe and his colleagues found that, after controlling for other factors, the cited patents were five to ten times more likely to come from other firms in the same metropolitan area. People were casually sharing and building on each other’s ideas. Jaffe’s finding also explains why it’s harder to take advantage of foreign countries’ knowledge if one is not located there: “culture geography and secrecy make knowledge harder to diffuse across international borders.”Erik Brynjolfsson and Adam Saunders, Wired for Innovation (Cambridge, MA: MIT Press, 2010), 99.

Below is a graphic from the Global Innovation Index. The graphic shows the main enablers that encourage innovation to take place in a given country. These enablers are Human Capacity, General and ICT (information and communication technology) Infrastructure, Market Sophistication, and Business Sophistication. On the right-hand side are the outputs of innovation—namely, scientific papers, patents, and new products and creative works. Companies evaluate the following things when choosing among countries in which to locate R&D facilities:

• A nation’s institutions (the political and regulatory environment)
• A nation’s investment in education
• A nation’s ICT infrastructure
• The sophistication of the market (access to investors and credit)
• Business sophistication (the innovation ecosystem and openness to competition)

© Global Innovation Index

Process Innovations

We typically think of new products and services as the innovation output of investments in research and development (R&D). However, a significant amount of innovation yields no new products or services, not because of R&D failure, but because the innovations are not related to a company’s core processes. A process innovationImplementing a new or significantly improved process. is an innovation in the way a company does any process, such as taking a customer order. A processA series of linked activities (steps, tasks, or subprocesses) that produce an intended result. is defined as “a specific ordering of work activities across time and place, with a beginning and end, and clearly identified inputs and outputs.”Thomas Davenport, Process Innovation (Cambridge, MA: Harvard Business School Press, 1993), 5. Processes can be simple activities (e.g., filling out a travel expense report), longer processes (e.g., issuing an insurance policy), or a broad set of activities (e.g., inventory management and distributions). The broader the process, the more impact innovating that process will have. For example, UPS made a process change when designing the routes its drivers follow when making deliveries. The company’s routes give preference to making right turns rather than left turns whenever possible. The reason is that right turns are easier, faster, and safer—and they save fuel compared to left turns. This “right turn” process innovation doesn’t involve the customer, but it helps UPS operate more efficiently.

Open Innovation

Among the latest developments in corporate innovation is the concept of open innovation. Open innovationGenerating new business ideas through input from employees beyond a company’s R&D department and even going outside the firm to enlist contributions from experts, customers, suppliers, and competitors. is the intentional leveraging of the research, ideas, or technologies of outsiders—that is, people or companies that are not part of the corporate entity—rather than relying solely on innovations that are generated from inside the company. Open innovation takes innovation beyond a company’s R&D lab and lets customers and partners participate in the creation of new product and services.

Procter & Gamble (P&G) embarked on open innovation in 2001 with its Connect + Develop program. For example, the innovation of printing text or images on Pringles chips came about through P&G partnering with a professor in Italy who ran a small bakery and had invented a technology that used ink-jet techniques to print pictures on pastries.Stefan Lindegaard, The Open Innovation Revolution (New York: John Wiley & Sons, 2010), 9. P&G adopted the technology to work with potato chips and launched Pringles Prints (chips with images and text printed on them) at a fraction of the cost and time it would have taken to research and develop the technology internally. Since adopting open innovation 2001, P&G’s innovation success rate has doubled, while its costs have decreased.Larry Huston and Nabil Sakkab, “Connect and Develop,” Harvard Business Review 84, no. 3 (March 2006), accessed January 2, 2011, http://hbr.org/2006/03/connect-and-develop/ar/1.

Another example of open innovation is from Kraft Foods. When Irene Rosenfeld took over as CEO of Kraft Foods, she saw an anemic innovation pipeline. The company had 2,000 corporate R&D staff—scientists, engineers and chemists—but new products weren’t flowing rapidly enough.Andrea Meyer, “Kraft: The ‘$40 Billion Start-Up’ Spurs Innovation,” Working Knowledge (blog), October 7, 2009, accessed February 27, 2011, http://workingknowledge.com/blog/?p=878. To solve the problem, she encouraged Kraft managers to reach out beyond corporate R&D and enlist the help of employees across the whole company, as well as suppliers and partners, to spur innovation. For example, Kraft runs an online “Innovate with Kraft” program whereby anyone can submit product ideas. The idea for Kraft’s Bagel-fuls (frozen bagels prefilled with Philadelphia Cream Cheese), for instance, came unsolicited from a bagel supplier. The idea was a win-win for both companies: it solved some technical challenges that Kraft had faced in delivering a bagel-and-cheese combo, and it boosted the revenue of the bagel supplier.

Innovation Contests

One method by which a company can manage and run open innovation is to use a contest or “challenge” method. In the contest method, the company poses a challenge, such as a way “to drop large amounts Humanitarian food and water packages from an aircraft into populated areas such that there is no danger of falling objects (i.e., nonfood items) causing harm to those on the ground” and offers a financial reward to the person, company, or team that solves the problem first.“Humanitarian Air Drop Challenge,” InnoCentive, March 2, 2011, accessed March 4, 2011, https://gw.innocentive.com/ar/challenge/overview/9932741.

Companies can run their own open innovation contests, or they can use a third-party provider like InnoCentive (which originated inside Eli Lilly and Company and was spun off as a separate company in 2005). InnoCentive runs contests via the web and has a community of more than 180,000 engineers, scientists, inventors, business professionals, and research organizations in 175 countries who regularly participate in its contests. Financial prizes as high as $1 million are awarded for the best solutions.

The advantages of the open innovation contest approach include the following:

1. Reduced cost of R&D because, rather than funding R&D projects that may fail, the contest approach pays the financial reward only after the solution is found. If no viable solution is found, the company does not pay the financial reward.
2. Faster product development time because multiple teams work on the project at the same time, with an incentive to be the first to develop a viable solution and thus win the prize.
3. Access to experts from around the world. The experts do not have to be employed by the firm but can still contribute an idea or solution. This gives a firm access to experts and talent which it couldn’t afford to employ full time.
4. Bigger breakthroughs because experts in a different field can make an unusual connection. For example, InnoCentive’s challenge to find a biomarker for ALS disease received a solution proposed by a dermatologist—someone completely outside the ALS research field but who had an idea for a low-cost testing method.

The contest method has had such success that now the US government also uses this approach to reward innovative solutions. See http://challenge.gov for the list of challenges that the government is running.

Role of Intrapreneurship in Corporate Innovation

Large multinationals that have R&D centers also look for other ways to encourage innovation and new ideas. One effective way to stimulate innovation is to devise ways for intrapreneurs to contribute their ideas. Let’s look at how one multinational, Shell, does this. Despite spending over $1 billion annually on R&D, Shell also runs a small program called GameChanger to foster radically innovative ideas. Started in 2006, GameChanger is a program to which any Shell employee anywhere in the world can contribute an idea for a product, project, or service. The program is open to nonemployees as well, making it an example of open innovation. Interestingly, about 70 percent of the proposed projects include at least one person who is not a Shell employee. (The nonemployee is typically someone associated with a university.)“Boston Consulting Group, Simulation Advantage,” Boston Consulting Group, accessed February 26, 2011, http://www.bcg.com/documents/file57197.pdf. Under the GameChanger program, a team of experts evaluates all the submitted ideas. Ideas that look promising are awarded funding of $15,000 to $25,000 so that the person who submitted the idea can expand on the proposal, possibly developing a prototype and attracting collaborators.Russell Conser, “Shell GameChanger: Space to Free the Mind,” Innosight 6, no. 4 (July–August 2008), accessed January 2, 2011, http://www.innosight.com/innovation_resources/article.html?id=628. Ideas that pass the next screening by a broader group of experts get funded to the tune of $500,000 to $1 million for a year. After that, the idea may be further developed by a Shell business, spun off as a separate company, or sold to another company.Wendel Broere, “Sparking the Spirit of Innovation,” July 13, 2007, accessed January 17, 2011, http://www.shell.com/home/content/innovation/innovative_thinking/game_changer/sparking_innovation/.

User-Led Innovation

The precursor to open innovation was the concept of user-led innovationInnovation by consumers and end users, who are using (or want to use) the product in new ways beyond what the company originally intended., first identified by MIT professor Eric von Hippel. Von Hippel noticed that many breakthrough innovations don’t come out of a company’s lab but rather from the lead users of the company’s products. In some cases, the lead users even precede a company. For example, von Hippel says that skateboards were the invention of people who took their roller skates and hammered a piece of board between them.Haydn Shaughnessy, “Eric Von Hippel on Innovation,” Innovation Management, February 21, 2011, accessed February 25, 2011, http://www.innovationmanagement.se/2011/02/21/eric-von-hippel-on-innovation/?utm_source=Subscribers+InnovationManagement.se&utm_campaign= 2780c497a9-Five+Steps+to+Profitable+Innovation&utm_medium=email. Companies later saw the popularity of the invention and took over the refinement and manufacture of skateboards. Similarly, von Hippel says, M-Pesa did not invent mobile banking. Rather, it saw people in Africa buying minutes for their cell phones and then transferring those minutes to relatives in lieu of money. M-Pesa made the process systematic so that money could be transferred between people who didn’t already have a relationship with each other—namely, for business.Haydn Shaughnessy, “Eric Von Hippel on Innovation,” Innovation Management, February 21, 2011, accessed February 25, 2011, http://www.innovationmanagement.se/2011/02/21/eric-von-hippel-on-innovation/?utm_source=Subscribers+InnovationManagement.se&utm_campaign= 2780c497a9-Five+Steps+to+Profitable+Innovation&utm_medium=email.

Social Networks

One of the features common to both open innovation and user-led innovation is the important and integral role played by social networks. A social networkA social structure made of nodes (which are generally individuals or organizations) that are connected by ties; a set of relationships among people. is a social structure made of nodes (which are generally individuals or organizations) that are connected by ties. In other words, it’s a set of relationships among people. Your social network is the structure of personal and professional relationships you have with others. Social capitalThe resources—such as ideas, information, money, and trust—that one is able to access through one’s social network., in turn, is the resources—such as ideas, information, money, and trust—that you’re able to access and influence through your social network. While social networks and social capital can be associated with many things, they’re particularly important sources of innovation.

In a typical company, innovation relies on a handpicked team leading an innovation project. The trouble is that these teams often have no good way of tapping the expertise of the whole company. They tend to call on the small circle of colleagues they know or on the acknowledged experts in an established field. But such teams often have a hard time identifying people they don’t already know but who might have knowledge relevant to the problem at hand. As a result, potential good ideas are lost or hidden—they remain inside the heads of unknown employees. That’s where social software tools come in handy. With social software tools, a company can start a discussion on a topic and employees who know about the topic self-identify by posting ideas, refining the ideas of others, and voting on ideas. That is, employees don’t need to be “found” by the innovation team. They can post ideas and thus self-identify and demonstrate their knowledge. For example, a company could start a discussion like “Can we develop a new water-filtration product?” People from market research might identify the top-selling filtration products. Someone from human resources who recently bought a water-filtration system for her family might contribute her own insights gathered from what blogs and outside websites were saying about all the competing products (e.g., “Brand B is bad because it’s difficult to install”). Other employees might point out the engineering deficits of a proposed technology, such as that a potential filter material is too expensive for consumer water filters. Another person might have good suggestions for how to solve the cost problem (e.g., to coat the expensive filter ingredient on a cheaper material). The point is that with the help of social networking tools, these contributions can come from any employee, not just the handpicked team members and their inner circle.Andrea Meyer, “Using Social Media to Improve Corporate Innovation,” Working Knowledge (blog), accessed March 4, 2011, http://workingknowledge.com/blog/?p=578.

Software tools that promote social networking are even more important when companies expand internationally, because it will be hard for innovation teams to personally know all the employees who could contribute innovative ideas. With enterprise-wide social networking tools, these employees can self-identify.

Contemporary View of BOP

In 1998, Professors C. K. Prahalad and Stuart L. Hart defined the bottom of the pyramid (BOP)Also known as the base of the pyramid, the market represents the four billion to five billion people living on less than $2 per day, typically in emerging economies. as the billions of people living on less than $2 per day. Both men expanded this definition of BOP in their subsequent writing (e.g., Prahalad’s The Fortune at the Bottom of the Pyramid in 2004 and Hart’s Capitalism at the Crossroads in 2005).C. K. Prahalad, The Fortune at the Bottom of the Pyramid (Upper Saddle River, NJ: Wharton School Publishing, 2004); Stuart L. Hart, Capitalism at the Crossroads (Upper Saddle River, NJ: Wharton School Publishing, 2005). The BOP is estimated to comprise between four billion and five billion people.

In Prahalad and Hart’s view, companies that understand the potential for commercial consumption at the BOP can open a new, potentially lucrative market that benefits the business as well as BOP consumers. By innovating to meet the needs of BOP customers, a company treats them with dignity and respect that previously was afforded only to the wealthy, Prahalad and Hart say.

Twelve Principles of BOP Innovation

Addressing the bottom of the pyramid requires a fresh managerial mind-set, summarized below in Prahalad’s “12 Principles of BOP Innovation”—which are innovations themselves.C. K. Prahalad, The Fortune at the Bottom of the Pyramid (Upper Saddle River, NJ: Wharton School Publishing, 2004), 25–27. In developed markets, Prahalad suggests that one may take the availability of electricity, telephones, credit, refrigeration, and other such amenities for granted. At the BOP, the infrastructure is much spottier and more hostile. Consumers may have to cope with frequent electric-power blackouts and brownouts. Credit may be extremely costly. Refrigeration may be unavailable. Products marketed to the bottom of the pyramid must be able to withstand such an environment.

Below are Prahalad’s “12 Principles of BOP Innovation,” along with examples of each.

1. Focus on value and on delivering performance for the price. The BOP consumer isn’t interested merely in cheap prices but in getting the greatest possible performance for the price paid. It’s extraordinary how low a price can be and still be highly profitable, if the seller is organized to deliver value. For example, doctors at India’s Aravind Eye Care System, the world’s largest eye-care business, perform hundreds of thousands of cataract surgeries each year. The prices range from $50 to $300 per surgery, including the hospital stay. Aravind is quite profitable, although 60 percent of its patients pay nothing.
2. Innovate. Old technologies can’t solve the problems of BOP consumers, and products aimed at the BOP market can’t simply be watered-down versions of developed-world products. Instead, products must be rethought to bring radically lower cost while at the same time having features that meet the BOP’s highest needs. For example, Hindustan Unilever Limited (HUL), a Unilever subsidiary, developed a new molecular encapsulation technology to prevent iodized salt from losing its iodine before consumption. To test the efficacy of the technology, the researchers used radioactive tracing techniques pioneered by the Indian Atomic Energy Commission.
3. Make the solution scalable. When delivering high performance at affordable prices, profits must be generated through volume sales. The product itself must be low cost, but with four billion to five billion BOP customers across the world, scaling the operation is what will make the venture sustainable. Solutions should be scalable across borders.
4. Aim to conserve resources. BOP consumers cannot afford to waste resources. Per capita water consumption in the United States is almost 2,000 cubic meters per year, compared to less than 500 in China and less than 700 in India. The developed world’s high standard of living is a water- and waste-intensive lifestyle. Innovations should emphasize conserving resources, recycling materials, and eliminating waste. Creating products for five billion people means designing the products in ways that can be environmentally sustainable. China’s focus on electric cars rather than gasoline-powered cars reflects the reality that it’s unlikely China could obtain the oil it would need for that many cars and that its extremely polluted cities could handle the additional exhaust fumes.
5. Identify functionality. BOP customers likely require different functionality than high-end consumers. For example, prosthetic legs developed for India’s BOP consumers needed to meet some special requirements: consumers needed to be able to squat, sit cross-legged, and walk on rough ground. Dr. Pramod Karan Sethi and Ram Chandra developed the Jaipur Foot prosthetic for this purpose. The charity Bhagwan Mahaveer Viklang Sahayata Samiti, which is based in Jaipur, India, made them available for less than $30.Tim McGirk, “The $28 Foot,” Time, accessed May 11, 2011, http://www.time.com/time/reports/heroes/foot.html.
6. Think in terms of process innovations. One way to bring costs down dramatically is to standardize processes. That’s how Aravind is able to bring down the costs of cataract surgery so dramatically. Aravind made the process highly standardized and trained young village women to prepare patients and handle postoperative care. Thus doctors focus exclusively on surgery and perform only cataract surgery—nothing else. This focused process lets one doctor and two technicians perform fifty surgeries per day.
7. Reduce the skills required to do the job. Design products and services suitable to people without skills. Voxiva, a Peruvian start-up, developed a system enabling health-care workers to diagnose illnesses such as smallpox by comparing a patient’s lesions to a picture of a similar lesion. With this simplified diagnostic process, health-care workers don’t require great skills to know when to call a doctor.
8. Educate consumers in the use of products. This may require collaborating with nongovernmental organizations (NGOs), governments, and others. HUL launched a program in some of India’s village schools to promote the washing of hands with soap as a way to prevent the childhood diarrhea that kills two million children per year. HUL educated the children, who in turn educated their parents.
9. Design products and services to operate in very tough infrastructure environments. For example, when Indian conglomerate ITC built a network connecting Indian villages, it had to provide personal computers that could handle wide voltage fluctuations. ITC included surge suppressors and solar panels to give the system adequate, reliable electricity.
10. Make the interface simple and the learning curve short. In Mexico, the chain retailer Elektra uses automated teller machines (ATMs) with a fingerprint identification system so BOP consumers don’t have to remember lengthy identification codes.
11. Innovate in distribution. Avon has built a Brazilian direct-sales business that delivers revenues of $1.7 billion annually.
12. Challenge assumptions. The Jaipur Foot and Aravind Eye Care System hospitals defy conventional wisdom about how (and at what price) it’s possible to deliver health care to the poor.