Radjou, N. (2004). Innovation Networks. Forester Research

June 17, 2004 Innovation Networks by Navi Radjou FORRESTER BIG IDEA

Helping Business Thrive On Technology Change FORRESTER BIG IDEA

June 17, 2004 Innovation Networks A New Market Structure Will Revitalize Invention-To-Innovation Cycles This is the ﬁrst document in the “Innovation Networks Boost Proﬁt” series. by Navi Radjou with Bobby Cameron, Erin Kinikin, and Liz Herbert

EXECUTIVE SUMMARY Finicky customers, ruthless competition, and stringent regulations are accelerating demand for technology-enabled innovation. But supply-side deficiency and ineffectiveness hamper firms’ ability to convert inventions into profitable innovations. The result? A new market ecosystem — called Innovation Networks — will emerge to match global demand for innovation with worldwide supply. Innovation Networks will let firms fluidly weave internally and externally available invention and innovation services to optimize the profitability of their products, services, and business models. Innovation Networks will deconstruct vertically integrated invention-to-innovation cycles in software, finance, and CPG industries — and reinvent the formula for success in regional, national, and global markets. TABLE OF CONTENTS NOTES & RESOURCES 2 Accelerating Demand For Innovation Forrester spoke with vendors, user companies, Outpaces Firms’ Supply and academic institutions, including: Arizona Six Ineffective Practices Stall The Invention-To- Technology Enterprises, Boeing, Deloitte Innovation Cycle Consulting, Harvard Business School, Knowledge Campus, Medtronic, Procter & Gamble, and 6 A New Market Structure Will Balance Stanford University. Innovation Demand And Supply Innovation Networks Will Accelerate The Related Research Documents Invention-To-Innovation Cycle “Near-Term Growth Of Offshoring Accelerating” May 14, 2004, Trends 11 Innovation Networks Will Reshape Tech- Dependent Industries First “Report On Technology Innovation: Q1 2004” January 6, 2004, Brief RECOMMENDATIONS 13 Firms Must Adopt Innovation Networks “CIOs: Break The ’IT Isn’t Innovative‘ Stereotype” Beginning With Their Core August 18, 2003, Brief

WHAT IT MEANS “Software Innovation Shifts To Platforms & 14 Innovation Networks Will Reshape Industries, Portfolios” Regions, And Countries August 22, 2002, Brief

ALTERNATIVE VIEW 16 Isolationist Policies And IP Laws Could Choke Innovation Networks 17 Supplemental Material

© 2004, Forrester Research, Inc. All rights reserved. Forrester, Forrester Oval Program, Forrester Wave, WholeView 2, Technographics, and TechRankings are trademarks of Forrester Research, Inc. All other trademarks are the property of their respective companies. Forrester clients may make one attributed copy or slide of each ﬁgure contained herein. Additional reproduction is strictly prohibited. For additional reproduction rights and usage information, go to www.forrester.com. Information is based on best available resources. Opinions reﬂect judgment at the time and are subject to change. To purchase reprints of this document, please email [email protected]. 2 Forrester Big Idea | Innovation Networks

ACCELERATING DEMAND FOR INNOVATION OUTPACES FIRMS’ SUPPLY Technology innovation fuels economic growth across developed nations, having helped generate productivity gains for the past nine years. IT investments account for about 48% of all US productivity gains and 41% of Japan’s economic expansion since 1995.1 And over the past 11 years, innovation variables like private-sector R&D spending explained 35% of GDP growth in Organisation for Economic Co-operation and Development (OECD) countries.2 Forrester deﬁnes innovation as occurring:

When inventions intersect a business process and change the way something is done, experienced, or created.

Firms face ever increasing pressure to accelerate their rate of invention and innovation in their products, services, and business models from (see Figure 1):

· Customers craving a constant ﬂow of new consumables. Tech-savvier Generation Y and health-conscious baby boomers — not just from Western countries but also from emerging economies like India and China — lust for new products and services that will enhance their lifestyle, like the latest DVD players and creative car insurance schemes. The result? Firms must not only keep reinventing their oﬀerings and business models but also adapt them to customers’ regional and individual needs. For instance, Atkins dieters are forcing R&D labs of food suppliers like Kraft Foods and Krispy Kreme Doughnuts to get low-carb products to stores fast — or see customer loyalty erode.3

· Competitors crushing proﬁtable new releases. Competitors create an innovation race. Winners must keep running to defend their titles as market life cycles truncate for even brand-new products — and new players completely change the game. For instance, despite spending $800 million and 12 years to get CELEBREX to market — and despite a 17-year patent exclusivity — Pﬁzer enjoyed a mere three-month market exclusivity before rival VIOXX was launched. And Norwich Union turned the European insurance industry upside-down by launching a telematics-enabled “Pay As You Drive” car insurance scheme.

· Governments grinding out new-economy regulations. Manufacturers and service ﬁrms are revamping their products, services, and business models as governments respond to the public outcry over privacy, safety, accounting, and environmental violations. For instance, the mad cow disease outbreak prompted the US Department of Agriculture to require cattle farmers and meat packers to use technologies like RFID and sensors to deliver end-to-end product traceability. And disclosure laws like the Sarbanes-Oxley Act and Basel II are forcing stodgy accounting ﬁrms to upgrade their transactional systems so they can report service performance in near real time.

Figure 1 Firms Are Facing Growing Demand For Accelerated Innovation s

Customers e

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ducts Innovation Competition Pro B iz m od Government els Catalyst How the catalyst accelerates invention-to-innovation cycles Customers Products • Atkins dieters are forcing food suppliers like Kraft Foods and Krispy Kreme Doughnuts to reinvent product lines. • Users’ need to drive cross-organizational synergies are forcing apps vendors like SAP to scramble to develop flexible process-centric apps, built from the ground up with Web services. • Suppliers of Wal-Mart and the US Department of Defense (DoD) must redesign their products and distribution services to support RFID tagging. Services • Financial service firms are struggling to respond to clients‘ growing interest in online payments. • Japan’s aging population is driving hotel operators to invest in safety and security technologies. Business models • Home Depot is forced to offer installation services to meet baby boomers’ “do it for me” needs. • The DoD wants its contractors to not only invent weapons but also maintain them in the field. Competition Products • Pfizer’s CELEBREX enjoyed only three months of exclusivity before the launch of competitor VIOXX. Services • Insurers are scrambling to match the “Pay As You Drive” scheme of rival Norwich Union. • Rival casinos envy Harrah’s ability to mine CRM data to tailor its services to individual customers. Business models • File sharing and P2P networks like KaZaA are threatening the music and media business. • VoIP and Wi-Fi startups are forcing Baby Bells like Verizon to revisit their fixed-line business model. Government Products • China wants foreign high-tech OEMs like Intel to comply with its own protocols and standards. • TREAD Act is driving tire suppliers like Michelin to embed sensors in tires to prevent blowouts. Services • US Customs Service requests logistics service providers to track all US-bound cargo from point of origin. Business models • Sarbanes-Oxley and Basel ask accounting firms to report service performance in near real time.

Source: Forrester Research, Inc.

Six Ineﬀective Practices Stall The Invention-To-Innovation Cycle Innovation should lead to accelerating growth through a virtuous cycle. Firms that successfully meet the demand for innovative products and services enjoy greater revenues. And these revenues fund increased R&D, which, in turn, drives more innovation — and so the cycle continues.4 But for many ﬁrms, this virtuous cycle falls apart because (see Figure 2):

1. One-way customer relationships yield market-irrelevant inventions. Obsessed with time-to-market, firms fail to capture customer requirements or test market ideas as they evolve — getting the wrong products or services to market fast. For instance, only 31% of firms in European services sector seek customer input when inventing new products.5 Similarly, firms’ R&D and marketing teams fail to consult with customer support and channel partners when developing new offerings — losing these partners’ innovative insights that could enhance end customers’ experiences.

2. Ivory-towered R&D labs dampen the rate of invention. Between 1990 and 2001, industry-ﬁnanced R&D in the OECD region rose 51% in real terms from $244 billion to $368 billion.6 Yet quantity doesn’t imply quality. Indeed, in-house R&D shops’ tendency to reinvent the wheel and their focus on perfection over practicality slows their productivity and dampens the innovation quality. Ninety percent of new chemical formulas never make it out of R&D labs.7 And while patents ﬁled by European researchers have been increasing 10% per year since the late ’90s, less than 10% of patents have commercial importance and less than 1% are of seminal importance.8

3. Organizational silos prevent collaborative idea generation. The cross-pollination of ideas to produce integrated solutions and exploit new markets — like the AOL Time Warner megamerger and Bayer’s $1.3 billion deal with CuraGen — runs into resistance from to incongruent incentive systems and organizationally siloed business processes that fail to span product units or divisions. For example, only 35% of multinationals have a central coordination body that formulates innovation strategies to cut through business unit boundaries.9

4. Risk-averse top management eschews radical innovation. Business unit execs avoid disruptive innovations they see as threats to existing product or service lines and business models. And Wall Street’s short-term revenue expectations drive risk-averse CEOs to deny funding for innovation initiatives that pay oﬀ only in the long term or that target non-core markets. That’s why 90% of R&D projects in CPG ﬁrms aim at sustaining existing products.10

Figure 2 The Innovation Engine Ain’t Starting — It’s Stuck In Low Gear

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ucts Innovation od Pr

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Impact on Impact on Impact on business Stifling factor product innovation service innovation model innovation One-way customer Blue-sky inventions Unheeded insights from Rivals exploit customer relationships substitute instinct for channel partners and intimacy to get buy-in consumer insight  customer support result for disruptive inventions  and fail miserably in lost revenue obliterating existing at launch. opportunities. business models. Ivory-towered R&D Reinvention of the wheel Failure to deploy innovative Process-based business and trial-and-error services opens the door model innovation outstrips development hamper for competitors and pure- many product and service discovery and exploitation play providers to gain inventions for business of original ideas. revenue and market share. impact. Organizational Clumsy knowledge Product-centric business “Customer-focused” silos transfer between R&D, units fail to exploit innovation strategy fails sourcing, production, and cross-unit synergies to due to misaligned sales hampers time-to- invent new product/service incentives and incongruent market. “bundles.” goals across divisions. Risk-averse “Not invented here” Sales and marketing reject Wall Street-fearing CEOs top management mentality prevents breakthrough service avoid expensive, experimentation with innovations that risk “long-shot” inventions with externally sourced ideas. cannibalizing existing, limited short-term revenue still-profitable offerings. potential. Unskilled partners Captive suppliers can’t Dedicated channel Competitors outinnovate rapidly upgrade their partners are unfit to sell by plugging talented assets and skills to meet and service radically new new suppliers and their customers’ innovation inventions in new markets. distributors into their requirements. value chain. Limited pools of US firms can’t find the skills Industrial OEMs in Western US DoD will struggle to local talent needed to invent  while countries will struggle to implement its Network- Japan, Europe, and China extend their product life Centric-Warfare vision outpace the US in creating cycles with value-added given the paucity of new Ph.D.s in science and services given their aging electronics and software engineering. manufacturing workforce. talent in its US supply base.

Source: Forrester Research, Inc.

5. Unskilled partners fail to keep pace with innovation. Suppliers’ input and channel partners’ selling abilities play primary roles in innovation success. But these value chain partners become bottlenecks instead when they fail to keep up. For instance, Ford’s and Boeing’s electromechanical part suppliers frustrate the OEMs’ need for more embedded electronics and software in cars and planes. And when Sompo Japan Insurance decides to resell Norwich Union’s products, the Japanese underwriter’s sales agents won’t be trained to apply dynamic pricing to car insurance.

6. Limited pools of local talent slow the innovation cycles. The focus on local, internal talent no longer works. In 1999, the US granted only 61,000 bachelor’s degrees in engineering compared with 103,000 in Japan, 134,000 in Europe, and nearly 200,000 in China.11 Even worse: Since the mid-1990s, engineering and physics Ph.D.s in the US declined by 15% and 22%, respectively — resulting in a severe skills shortage.12 One particular victim? The US industrial sector — which won’t ﬁnd local talent to ﬁll in the 5.3 million high-skilled jobs it will generate in 2010 or the 14 million more generated in 2020.13

A NEW MARKET STRUCTURE WILL BALANCE INNOVATION DEMAND AND SUPPLY Firms face an innovation “double whammy.” While demand for technology-enabled innovation explodes, companies’ ability to meet that demand declines. And the traditional mechanisms for innovation sourcing and commercialization that should solve this imbalance have actually created it. To meet the pressures from customers, competition, and regulations, leading companies are replacing their rigid and restrictive approach to innovation. These ﬁrms are adopting a ﬂuid market ecosystem that matches global demand for innovation with worldwide supply. Forrester calls this dynamic market structure “Innovation Networks” in which (see Figure 3):

Firms seamlessly weave internally and externally available invention and innovation services to optimize the proﬁtability of their products, services, and business models.

Four specialist roles provide the services that make up Innovation Networks — Inventor, Transformer, Financier, and Broker (see Figure 4). In this fluid invention-to-innovation cycle, firms will no longer have to invent to succeed. Instead, companies will easily mix internal and external sources for services. And like athletic “all-arounders,” many firms will play multiple roles, simultaneously producing and consuming invention and innovation services (see Figure 5).14 Three factors will determine the Innovation Network roles a company plays:

Figure 3 Innovation Networks Revitalize Firms’ Approach To Innovation

Today Innovation Networks Corporate ethos Not invented here Best from anywhere

Role of customers Passive recipients of inventions Active co-innovators

Focus on core competitive diﬀerentiation Core competency Vertically integrated product and service design and delivery along with collaborative partner management

Innovation fo Economies of scale  with products and Economies of scope  with individualized cus service built around core competencies solutions optimizing end customer value

Increased margins/revenues, Eﬃciency of networks, Innovation success metrics reduced time-to-market, and responsiveness to demand, and share growth within existing markets expansion into new markets

Attitude toward IP Own and protect Share and expand

Role of R&D and Design, develop, and market Optimize performance of owned assets in both in-house and external operations in-house inventions invention-to-innovation cycles

Source: Forrester Research, Inc.

Figure 4 Innovation Networks Consist Of Four Types Of Organizational Models

Business model Specialization Intellectual powerhouses that conduct basic science Innovation Network research and/or design products and services that result in patentable inventions. Inventor Example: MIT, IDEO, SRI, GE Global Research, KAIST, Celera, Oxford, Microsoft Research, HP Labs, CNRS, Persistent, IIT Multifunction production and marketing services that convert inputs from Inventors and other Transformers into valuable business innovations for either internal or external customers. Transformer Example: Dell, Pﬁzer, BP, Merrill Lynch, SAIC, IBM, Infosys

Funding source for Innovation Network service providers  especially Inventors and startup Transformers. Financiers will seek to own intellectual property rights for inventions. Financier Example: Cargill Ventures, Silicon Valley Bank, Garnett & Helfrich Capital, InterActiveCorp, ICICI Bank, Vulcan, IP2IPO

Market makers that ﬁnd and connect Innovation Network service providers  buying and selling or enabling service delivery both within and among companies. Example: Knowledge Campus, yet2.com, PLX Systems, Big Broker Idea Group, InnoCentive, Evalueserve, ISTC, Intellectual Ventures, P&G’s Technology Entrepreneurs, DCMA, METI, TiE Source: Forrester Research, Inc.

Figure 5 Rather Than Specialize, Firms Will Juggle Multiple Innovation Network Roles

Example: Interaction patterns among partners within Procter & Gamble’s Innovation Network

P&G 1

Collaboration scenario

Scenario Description of P&G’s roles in the scenario P&G employs 7,500 inventors in 20 global R&D centers; it’s the second-largest patent 1 filer in the US. But P&G’s InnovationNet organization brokers ideas generated by 18,000 innovators hailing from across the firm, including non-R&D groups like purchasing.

P&G’s Equity Ventures group ﬁnances internal skunk projects or external 2 startups. For instance, the group took equity position in a medical device startup to transform a microneedle technology — invented by P&G — into a drug delivery system.

P&G’s scientists co-invented, with university researchers in the US and Denmark, 3 proprietary protease and cellulase enzymes with robust stain removal capabilities. Plant engineers at P&G and its suppliers transformed them into manufacturable goods.

As part of its Connect & Develop program, P&G has 55 globally spread Technology 4 Entrepreneurs who broker internal innovation requirements with external inventions (“external” nodes include other P&G business units).

Source: Forrester Research, Inc.

· Firms will choose in-house ownership for inventions core to their business. Companies will work to create those products, services, and business models that differentiate them in the market. For example, Cisco Systems chooses to own the inventions core to new product designs but turns to third parties to transform those into finished goods. And P&G might broker and finance inventions from either internal or external sources, but it will own the core intellectual property (IP) while licensing non-core IP to external brokers and transformers.

· Established companies will use third parties to mitigate risk in immature markets. Innovation Networks will let firms choose when to partner and when to “go it alone.” For instance, a risk-averse medical device provider like Johnson & Johnson may want to avoid cannibalizing its existing business with a breakthrough discovery. Instead, it will broker the disruptive invention to a startup to transform the invention into a successful innovation — with the original firm keeping the IP and playing the role of financier. But once the discovery achieves market acceptance, the original firm can bring the transformation activities back in-house, to enhance the overall brand and to take advantage of economies of scale.

· Aggressive ﬁrms will drive time-to-market by sharing Innovation Networks roles. Innovation Networks will turn the traditional serial invention-to-innovation process on its head — like what spiral software development did to the waterfall approach. Inventors and transformers will work in parallel to iteratively optimize innovations. At Intel, as soon as the Hillsboro, Ore.-based material scientists begin work on a new chip, its Indian programmers simultaneously initiate work on the ﬁrmware, while manufacturing engineers transform their foundries’ production process to speed time- to-market — sharing learning as they progress.15

Innovation Networks Will Accelerate The Invention-To-Innovation Cycle The Innovation Network market structure will fuel the tech-enabled invention-to- innovation virtuous cycle. Fluid collaboration among buyers and sellers of Innovation Network services optimizes the returns from these services by taking advantage of cross- unit and global, multiﬁrm opportunities. This success in turn funds the growth of more inventions and innovation — unleashing a self-sustaining cycle. As a result, Innovation Networks remove the six stumbling blocks in traditional, internally owned invention and innovation as ﬁrms:

1. Co-innovate with customers. Because customers — and their customers — plug directly into Innovation Networks, ﬁrms will get rapid market feedback on new product and service ideas and will quickly adapt existing solutions and business models to attack new markets. For instance, IDEO’s designers collaborate with customers’ customers to generate new ideas. And GE Plastics’ Design Solutions Center’s customers use Moldﬂow’s software to specify resin requirements online.

2. Expand R&D productivity through partnerships. In-house scientists and engineers will stop reinventing the wheel and boost their productivity by tapping inventors directly or by using brokers like InnoCentive and tools like Invention Machine to

discover original design insights and tips and shortcuts. For example, Eli Lilly’s 6,000 researchers use 25,000 “solvers” — freelance researchers in 125 countries available on InnoCentive’s Innovation Network — to ﬁnd answers to vexing scientiﬁc conundrums, frequently as fast as within 24 hours.

3. Harvest invention-to-innovation cycles across internal organizations. Large corporations will deploy the Innovation Networks model inside their global organizations. They will broker Innovation Network services across operating units as well as transform cross-functional product and service inventions into integrated solutions. For instance, Capgemini’s CTO oﬃce tracks not only emerging technologies but also internal specialists needed to swiftly transform inventions into business solutions of value to industry clients.

4. Share the risk of exploiting disruptive innovations. Rather than eschew core-market- threatening inventions, CEOs will court disruptive innovations, finance them through joint ventures or equity partnerships, and use brokers to sell them in new markets. When The Dow Chemical Company decided to “grow” plastic using non-petroleum resources, its financial arm set up a joint venture with food giant Cargill — Cargill Dow — to invent a fermentation technology that can transform corn into fibers.

5. Shift suppliers fluidly to match the innovation services required. Instead of being restricted by their traditional suppliers’ talents, firms will source the Innovation Network services they need from the global family of firms, industries, and academic institutions — and even from competitors (see Figure 6).16 For instance, Ford chose to license hybrid engine technology invented by archrival Honda rather than wait for its unskilled suppliers to catch up. And IBM — despite its 22,357 patents, $4.75 billion R&D spend, and partnerships with vendors like i2 and SAP — is financing On- Demand Supply Chain Research Laboratories at four major universities to co-invent on-demand services.17

6. Scout for talent across national boundaries. Firms in Western countries will let global market opportunities — not their local country’s skills base — direct their innovation sourcing as they woo inventors in talent-rich China, India, and Russia. For instance, Blue Cross Blue Shield transforms health insurance product models invented by Russian outsourcer EPAM Systems into innovative business oﬀerings for its US- based clients.18 And US investment banks are subcontracting basic equity research to Indian M.B.A.s who work for service providers like Evalueserve.19

Figure 6 Innovation Networks Swell The Supply Base For Innovation Talent And Ideas

New source Key innovation services provided Examples of firms using the source Contract Invention: Contract labs in India, China, and • Boeing employs 400 Russian engineers research Russia employ thousands of math/science/ who conduct analytics and simulation. labs engineering PhDs  at a fraction of US salaries. • DoD is a major Sarnoff customer. Transformation: Labs like Sarnoff’s are great • Investment banks use Evalueserve’s at converting raw invention into usable goods. MBAs to conduct basic equity research. Academia Invention: In US industry 73% of all citations • GlaxoSmithKline will build a £76M clinical patents originate from academic research. imaging center at Imperial College London. Brokering: Bayh-Dole Act of 1980 lets US • Intel has five “lablets” in major universities license federally funded research. universities.

Military Invention: DARPA invented the Internet  and • SAIC, an IP-intensive defense supplier, now does R&D around X Internet technologies. makes one-fourth of its revenues from Financing: LaunchPower and In-Q-Tel, CIA’s VC innovation deals with the private sector. arm, fund military and commercial innovations. • BankOne’s ePayment services  used by the Brokering: DoD’s ManTech Program helps Dept. of Homeland Security  are now transfer military technologies to available to commercial clients. manufacturing sector. Competitors Invention: Firms can source IP-related to • Ford licensed Honda’s hybrid engine IP. product, service, biz model from competitors. • Norwich Union licensed PAYD business Transformation: Rivals’ insights can accelerate model IP from Progressive Insurance time-to-market of non-competitive inventions. • Big Pharma’s external alliance spend Financing: Co-investment in new technologies rose from $1.4B (1993) to $26B (2000). of common interest is a win-win proposition. Customers Invention: Customers can offer valuable • 3M uses “Voice of Customer” tools to get feedback on product and service ideas. market validation on product ideas. Brokering: Viral marketing brings more insight • Medtronic co-invents with patients. and speeds invention-to-innovation cycles. Free agents Invention: Firms can use the Net to • Staples’ Invention Quest received 8,300 ideas cost-effectively identify and work with nationwide in 2003. independent entrepreneurs worldwide. • Eli Lilly pays scientists who solve tricky Brokering: Referrals accelerate discovery of problems it posts online with InnoCentive. prequalified new talent.

Source: Forrester Research, Inc.

INNOVATION NETWORKS WILL RESHAPE TECH-DEPENDENT INDUSTRIES FIRST Not all companies will embrace Innovation Networks at the same pace. IP-intensive firms — under Wall Street pressure to maximize the profitability of intellectual assets — and businesses forced to accelerate the pace of innovation by market realities will make the move first as:

· Electronics manufacturers seek to maximize return on their core assets. OEMs like Cisco, Medtronic, and Dell already outsource their manufacturing to transformers like Solectron and Quanta Computer. As they seek business model ﬂexibility to survive ruthless price wars and expand into new products and markets, these OEMs will tap

external Innovation Network services to keep their core assets fully optimized. Expect Dell to out-transform HP’s in-house printer inventions by ﬁnancing inventions of HP rival Lexmark.20 And medical device makers will mimic Medtronic — which generates 66% of its revenues from products that are less than two years old — by co-inventing X-Internet-enabled devices with physicians and patients.21

· Software companies push platforms to match users’ business innovation needs. Open source vendors like Red Hat have given IT buyers a positive taste of Innovation Networks at work as multiple inventors contribute to a single set of IP. And users seeking business-process innovation have begun demanding a similar level of creativity from packaged business solution vendors like PeopleSoft and i2.22 This will, in turn, force leading infrastructure vendors like IBM and BEA Systems — as well as apps suite suppliers with proprietary architectures like SAP and Oracle — to shift their software innovation focus to Innovation Networks. They will have to nurture and promote innovation using their software platforms to compete — much like Microsoft already nurtures its ecosystem.23

· Financial services firms strive to optimize their innovation capabilities. Net- informed customers increasingly seek innovative pricing and offerings from their providers, even sometimes forcing competitors to work together in Innovation Networks. For example, Norwich Union — which doesn’t do business in the US — licensed the innovative telematics-based PAYD business model from US-only player Progressive Casualty Insurance. This allowed Progressive’s inventor capabilities to benefit from Norwich Union’s market transformer reach.

· Big Pharma deconstructs to meet global pressures from aging baby boomers. The aging world population is exploding — every day, 10,000 more Americans turn 50 years old — and this group demands the best care at the best price.24 This pressure is forcing Big Pharma to give up its vertically integrated innovation model, which requires $800 million and 12 years to invent a drug. Instead, drug manufactures like Eli Lilly are creating Innovation Networks that take advantage of the established roles of leading players — and share the risk and costs of research, development, and marketing.

· CPG firms scramble to deliver global efficiencies with local fit. CPG firms will rush to adopt Innovation Networks to balance their need for innovative products and worldwide operational effectiveness with the demands of governments and retailers. For example, local regulations for food safety and retailers’ calls for special handling — like Wal-Mart’s pallet-level RFID tagging mandate — will cause Nestle’s CEO to turn to networks of innovation partners to realize his call for Nestle to deliver new products “wherever, whenever, and however.”

· Chemicals industry players seek R&D productivity and regulatory compliance. To break loose from its historical failure to convert inventions into business — and to comply with regulations like The Bioterrorism Act of 2002 — chemical firms will seek partnerships in Innovation Networks.25 Look for forward-thinkers like BP and Air Liquide to transform other firms’ inventions into tailored formulations and services that match customers’ specific application needs.

· Defense contractors respond to the US government’s demand for innovation. The US Department of Defense (DoD) is demanding an accelerated adoption of high- tech innovations, forcing the adoption of Innovation Networks. Commercial aircraft makers have already embraced Innovation Networks — 65% of Boeing’s new 7E7 is engineered by suppliers like Mitsubishi Heavy Industries. But the DoD is having to force asset-hoarding defense contractors that favor in-house R&D and M&As over innovation partnerships. To win the $300 billion Joint Strike Fighter project, Lockheed Martin had to convince the Pentagon that it can co-innovate with rivals.

RECOMMENDATIONS

FIRMS MUST ADOPT INNOVATION NETWORKS BEGINNING WITH THEIR CORE Innovation Networks may accelerate the invention-to-innovation cycle while increasing the chances for success, tempting firms to look outside for success. But firms won’t win unless they shed their risk-aversion and “not invented here” attitudes and inject fluidity into their internal invention-to-innovation processes. Companies will tackle this internal adoption the quickest if they:

1. Turn each employee into an inventor. Instead of relying on R&D labs or product development teams as their only innovation sources, firms will scout for ideas in every department and division — from plant workers and field technicians to mailroom clerks. And these firms will invest in idea management tools from vendors like Resultor and Centric Software to collect and share insights organizationwide. For example, apparel maker Zara’s store clerks are equipped with wireless PDAs so they can zip design tips and shopper preferences directly over to Zara’s designers. 2. Drive cross-unit transformation synergies. Sharing ideas won’t produce innovation until firms institute cross-unit execution teams that can draw on firmwide operational capabilities to rapidly convert ideas into market-friendly innovations. That’s why Ingersoll-Rand created its Dual Citizenship program that supports the integrated design and delivery of innovative solutions by drawing upon product and service synergies across the manufacturer’s divisions.

3. Heed the needs of lead customers to drive breakthroughs. Input from mainstream customers must underpin the incremental innovation of existing offerings. But for breakthrough innovation, mainstream customer input has less impact and can even mislead — until Charles Schwab’s explosive success online, no Merrill Lynch client would have clamored for discount brokerage services. For example, 3M relies on “Voice of Customer” for incremental innovation, but generates breakthrough inventions with input from its “lead users” — those moving ahead of market trends.26 4. Tie R&D and sales compensation to Innovation Network activity. In Innovation Networks, R&D’s job will be to “source from anywhere” — a job profile that doesn’t fit many of today’s scientists stuck in a “not invented here” mindset. To drive change, firms must ditch old performance metrics like “number of patents filed” and tie R&D’s bonus to Innovation Network metrics like “percent of ideas externally sourced” and revenue generated from IP sales. Similarly, sales and marketing bonuses should be based on their success at linking internal IP with external buyers. For example, Air Products and Chemicals credits licensing revenues to its business units. As a result, each unit has an IP licensing team — made up of R&D and marketing managers — that meets once a quarter to find ways to increase licensing opportunities for in- house inventions. 5. Continue financing failures but actively manage risk. C-level execs should fund and support risky innovations but mitigate that risk through Innovation Network approaches — like spinoffs and cross-unit R&D/business alignment. And to stay on top of this complex model, firms should emulate HP. The high-tech player uses advanced valuation tools like real options to continually update its R&D projects’ risk profile. And HP applies dynamic portfolio management techniques to regularly reallocate capital across its innovation initiatives.

WHAT IT MEANS

INNOVATION NETWORKS WILL RESHAPE INDUSTRIES, REGIONS, AND COUNTRIES Innovation Networks will both deconstruct vertically integrated invention-to-innovation processes and reinvent the formula for regional and national success as: · Software users invent and ISVs transform. Microsoft already uses direct feedback from millions of beta users to incrementally innovate its software. And IBM today harnesses open source developers to accelerate the innovation of its middleware, database, and server software. But in years to come, users — like IT-savvy Charles Schwab and IP-intensive P&G — will partner with ISVs (independent software vendors) like SAP and systems integrators like Accenture to transform their

business process inventions into application offerings for use by other firms. For instance, Amazon.com is looking for brick-and-mortar retailers willing to license its homegrown order fulfillment technology. And SAP is tapping Ford’s process expertise to invent a service management app for automakers. · Nonprofit inventions transform developing nations. Nonprofit firms and NGOs (non-governmental organizations) can’t afford to spend billions in R&D and couldn’t commercialize inventions even if they had them. But NGOs can accept patented inventions as donations and they can transform and finance innovations for charitable purposes. Case in point: Aurolab — a charitable trust founded by entrepreneur David Green — manufactures low-cost hearing and ophthalmic devices for the rural Indian population. What’s next? Expect the Toyota Foundation to transform Toyota’s fuel-cell technology into a low-cost power supply for Botswanian villages. And expect the Aga Khan Foundation to donate biotechnology IP bought from DuPont to Afghan growers of UN-approved “orphan crops” like pearl millet, sorghum, and teff. · The “C” and “G” in CPG get redefined. CPG giants like P&G and Unilever will drive their brand managers to market intellectual property while their logistics experts are hired to modernize shipping and receiving by pharmaceutical firms and auto OEMs — based on perfected demand forecasting and vendor managed inventory processes. Today the innovation locus in CPG is tangible goods — sold via channel masters like Wal-Mart. But as Jeff Weedman, P&G’s VP of External Business Development and Global Licensing, said, “Our customers aren’t just consumers buying Tide detergent. It’s also other companies — from any industry — looking to source P&G’s intangible products, such as intellectual assets, brands, knowledge, and know-how. ” · Silicon Valley brokers, Boston invents. Regional strengths will focus on Innovation Network roles. Silicon Valley’s multicultural high-tech workforce will apply its deep managerial expertise to broker innovation between US-based buyers and inventors in India, Russia, and China. VCs on Sand Hill will use their connections with local entrepreneurs to identify market needs and emerging trends — and fund R&D talent in Asia and Europe. And academic-rich Boston will woo inventors of emerging technologies that outpace Europe and Asia-Pac, such as biotechnology and nanotechnology. · The empire strikes back as India finances UK inventions. Expect Indian firms with global ambitions to scout for talent worldwide. Infosys and TCS are already funding RFID research at academic powerhouses like The Wharton School and CMU. And smelling an opportunity, the UK’s Department of Trade and Industry will facilitate — through brokers like Knowledge Campus — access to the UK’s academic and industrial labs, exploiting its historical ties with India to forge a strategic innovation alliance with the Indian government.

ALTERNATIVE VIEW

ISOLATIONIST POLICIES AND IP LAWS COULD CHOKE INNOVATION NETWORKS For Innovation Networks to take off in the commercial world, globally applicable rules and procedures must first be instituted to facilitate networked generation and exploitation of intellectual property across firms. What could hamper this progress? · Asia’s proprietary standards and absence of IP ownership laws. The Chinese government’s insistence that all wireless chips sold in the country conform to a proprietary standard led Intel to stop shipping Wi-Fi chips to China, despite its huge market. And Cisco is still involved in a bitter copyright lawsuit with Chinese rival Huawei, accused of stealing Cisco’s router code. India doesn’t fare any better. Its generic drug makers like Cipla and Dr. Reddy’s Laboratories have overcome puncture- proof patent protection by reverse-engineering patented drugs and reproducing them using proprietary development processes. India did sign the agreement on Trade-Related Aspects of IP Rights (TRIPS).27 But unless its judiciary system upgrades to enforce TRIPS by 2006, it will fail to attract not only R&D work from Big Pharma and foreign media companies but also investment capital from abroad. · Europe’s lack of a pan-EU patent regime. Question: How would a Chicago-based firm feel if it had to separately file patents for its invention in all 50 US states? Answer: Like a French engineer or a Swedish scientist. The European Patent Office — which is not a European Union governmental institution — is understaffed and crippled by outdated practices. A recent proposal to streamline these practices — by harmonizing European patent laws — was rejected by EU ministers.28 Such an outdated patent regime and the resulting paucity of venture capital may explain why 400,000 European scientists decided to leave for the US.29 · The US’ confused policies of isolationism mixed with collaboration. Unless Washington, DC, drives political consensus on the topic of outsourcing, the US won’t play a leadership role in nascent global Innovation Networks. Democratic presidential candidate John Kerry is threatening to tax US firms that source innovation from overseas — and Republican senators sponsored a Senate bill that bans outsourcing of government jobs.30 But last January, the Bush administration quietly signed a strategic R&D cooperation agreement with India in civilian nuclear, space, and high-tech areas.31 Such schizophrenic comments and attitudes across the political spectrum can give jitters to innovation-seeking US firms — and lead to counterattacks by talent-rich China and India.

SUPPLEMENTAL MATERIAL Companies And Experts Interviewed For This Document

3M Knowledge Campus Arizona Technology Enterprises Medtronic Aspen Technology Procter & Gamble Boeing Sarnoﬀ ClearForest Sopheon Deloitte Touche Tohmatsu Stanford University Evalueserve Synopia Harvard Business School yet2.com Invention Machine

ENDNOTES

1 The US Department of Commerce reports that US productivity grew 2.7% per year from 1995 through 2000, and 3.8% since 2001. And in 2003, Professor Dale W. Jorgenson at Harvard University and Professor Kazuyuki Motohashi at the University of Tokyo found that IT investments accounted for 41% of Japan’s economic growth in the ’90s.

2 OECD — whose 30 member countries include the US, Japan, Germany, Greece, and Mexico — correlates innovation to growth. Source: http://www.3i.com/pdfdir/innovation_ecosystem.pdf.

3 In his investor call in May 2004, Krispy Kreme President and CEO Scott A. Livengood insisted the low-carb diet trend was to blame for the company’s ﬁnancial woes.

4 Nobel Prize-winning economist Robert M. Solow perfected this virtuous cycle growth theory — rooted in Joseph Schumpeter’s seminal work on innovation. Solow’s 1957 paper demonstrated that 90% of the rise in US prosperity during the ﬁrst half of the 20th century came from technology-enabled growth.

5 The European Union’s third round of Community Innovation Surveys (CIS3) provides this information on the sources used by European industrial and service companies in their innovation activities. Source: http://europa.eu.int/comm/eurostat/Public/datashop/print- product/EN?catalogue=Eurostat&product=KS-NS-04-005-__-N-EN&mode=download.

6 The OECD tracks and reports the R&D spending in its member countries. Source: http://www. oecd.org/dataoecd/48/12/24508541.pdf.

7 Nine out of 10 ideas never make it out of R&D labs, and one-third of launched products eventually fail. See the January 2001, Report “Custom Chemicals Materialize.”

8 While the OECD reports growth in patents ﬁled in Europe, a report sponsored by the Lemelson- MIT Program warns that most ﬁled patents have little commercial value. Sources: http://www. oecd.org/dataoecd/48/12/24508541.pdf and http://web.mit.edu/invent/n-pressreleases/ downloads/report.pdf.

9 Multinationals lack a formal and consistent invention-to-innovation process that cuts across all their global units. Source: Kathryn Troy, “Making Innovation Work: From Strategy to Practice,” The Conference Board, April 2004.

10 According to the “1997 PDMA Report,” the percentage of product development projects that represents products that are “new to the world” remains constant at 10%.

11 The US accounted 7% of the 868,000 bachelor’s-level engineering degrees granted worldwide. Source: National Science Foundation’s “Science and Engineering Indicators 2002.”

12 The National Science Foundation has warned that unless national R&D (both public and private) is increased fourfold, US ﬁrms will fail to meet the demand for tech innovation within a decade. Source: National Science Foundation’s “Science and Engineering Indicators 2003.”

13 While everyone in the US is worried about manufacturing jobs being outsourced, the National Association of Manufacturers has expressed concern about the looming skills shortage. Source: http://www.nam.org/s_nam/doc1.asp?CID=200107&DID=226943.

14 Firms will play this dual role of producer and consumer by bringing their innovation processes online as reusable business services — a strategy that Forrester calls Organic Business. See the March 18, 2004, Big Idea “Organic Business.”

15 Intel’s Web site features an interview with Colin Evans, director of Intel’s System Software Lab, who describes the interdependencies between hardware and software design. Source: http://www. intel.com/labs/features/sw05031.htm

16 Despite success stories like Stanford’s and MIT’s — which spun oﬀ 4,000 companies — most universities have been largely untapped by ﬁrms as a source of innovation.

17 In November 2003, IBM announced it will create supply chain research labs at MSU, ASU, Penn State, and University College Dublin. Source: http://www.ibm.com/news/us/2003/11/201.html.

18 A track record of well-executed projects and long-term relationships with clients in the West demonstrates that Russian software development providers offer a credible offshore option. See the May 6, 2004, Tech Choices “An Anatomy Of Russian Offshore Software Developers.”

19 Forrester’s latest offshore outsourcing research finds that the number of US services jobs that will go offshore will increase in the near term. See the May 14, 2004, Trends “Near-Term Growth Of Offshoring Accelerating.”

20 The May 24, 2004 New York Times article, “The Distributor vs. The Innovator,”by Steve Lohr, quoted Michael Dell as saying, “The days of engineering-led technology companies are coming to an end.”

21 Technology in, on, and around the body will free care from formal institutions. See the December 17, 2002, Brief “Healthcare Unbound.”

22 Forrester believes that ﬁrms will redeﬁne how they look at IT — moving from today’s tech-centric focus to a more process-oriented approach that Forrester calls synchronized deployment. See the June 25, 2003, Brief “Executive Overview: Synchronized Deployment.”

23 The Internet’s discovery phase was fueled by massive innovation from startups. But in the build- out phase of the next 10 years, innovation will shift to the platforms and portfolios of software giants like Microsoft, SAP, and IBM. See the August 22, 2002, Brief “Software Innovation Shifts To Platforms & Portfolios.”

24 By 2020, the world’s population is expected to include more than 1 billion people aged 60 and above. Source: National Academy on an Aging Society, www.agingsociety.org.

25 Passed post-9/11, The Bioterrorism Act of 2002 recommends that chemical ﬁrms tap technologies like sensors, biometrics, and RFID to thwart terrorist attacks on chemical plants and shipments.

26 In the mid-1990s, 3M rolled out the “lead user” process — which seeks innovative insights from individuals that are well ahead of market trends. Source: Eric Von Hippel, Stefan Thomke, and Mary Sonnack, “Creating Breakthroughs at 3M,” Harvard Business Review, September 1, 1999.

27 TRIPS — which emerged from the WTO negotiations in 1994 — requires all WTO members to provide minimum standards of protection for a wide range of intellectual property rights — including copyright, patents, trademarks, and industrial designs. TRIPS took eﬀect in 1995. Developed countries were given one year to comply — with developing nations asked to enact TRIPS by 2006.

28 On May 18, 2004, EU governments killed a proposal aimed at unifying Europe’s disparate patent laws.

29 Europe’s best and brightest scientiﬁc minds are leaving in droves for the US — and billions of euros and thousands of jobs are at stake. Source: “How To Plug Europe’s Brain Drain,” Time Europe Magazine, January 19, 2004.

30 The bill, passed by the US Senate in March 2004, stipulates that private companies to which government agencies have outsourced work can’t use oﬀshore labor for the job.

31 On January 12, 2004, President George W. Bush issued a statement unveiling US cooperation with India in three areas: civilian nuclear activities, civilian space programs, and high-tech trade. Source: http://www.whitehouse.gov/news/releases/2004/01/20040112-1.html.

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