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© 2008 Henry Chesbrough 1
Business Model Innovation:
The Next Frontier in Innovation
Presentation on the Occasion of
the Launch of “Open Business Models”
Firenze, Italia
Henry ChesbroughHaas School of Business
UC Berkeley
© 2008 Henry Chesbrough 2
The Current Paradigm:
A Closed Innovation System
ResearchResearch
InvestigationsInvestigationsDevelopmentDevelopment New ProductsNew Products
& Services& Services
The
Market
Science
&
Technology
Base
R D&E
© 2008 Henry Chesbrough 3
Great Successes from the Closed
Innovation Model
• The Venetian Glass Industry
• The Roman Catholic Church
• The Chemicals Industry – Germany and later US
• Edison, GE, and the rise of electrification
• Vannevar Bush – Science: The Endless Frontier
• Chandler: Internal R&D key to the rise of the
modern US corporation in 20th century
© 2008 Henry Chesbrough 4
Hidden Assumptions in the Internally-
Focused Innovation System
If I discover it, I will find a market for it.
If I discover it first, I will own it.
The important technologies I will need can be anticipated
in advance.
“Misfits” are regrettable, but are a cost of doing business.
The best people in this field work for us.
© 2008 Henry Chesbrough 5
Current
Market
Internal
Technology
Base
R D
The Open Innovation Paradigm
Technology Insourcing
New
Market
Technology Spin-offs
External
Technology
Base
Other Firm’s
MarketLicensing
6 C 2002 Henry Chesbrough EIRMA SIG III, 2005-10-20
Closed innovation
Our current
market
Our new
market
Other firm´s
market
Open innovation
External technology
insourcing
Internal
technology base
External technology base
Stolen with pride from Prof Henry Chesbrough UC Berkeley, Open Innovation: Renewing Growth from
Industrial R&D, 10th Annual Innovation Convergence, Minneapolis Sept 27, 2004
Internal/external
venture handling
Licence, spin
out, divest
© 2008 Henry Chesbrough 7
The Logic of “Open Innovation”• Good ideas are widely distributed today. No one has a monopoly on useful knowledge anymore.
• Financial managers must play poker, as well as chess, to capture the value in false negatives.
• We must manage IP in order to manage research:
– need to access external IP to fuel our business model
– need to profit from our own IP in others’ business model
• Not all of the smart people in the world work for us.
© 2008 Henry Chesbrough 8
What is Innovation?
Before
• Invention
• Product
• Technology-driven
• Internally generated
• Engineering’s job
© 2008 Henry Chesbrough 9
What is Innovation?
Before
• Invention
• Product
• Technology-driven
• Internally generated
• Engineering’s job
After
• Commercialization
• Business, including
process and biz model
• Business/value-driven
• Internal Integration of
int. and ext. stuff
• Everyone’s job
© 2008 Henry Chesbrough 10
What is a Business Model?
• Creates Value
• Captures a portion of that value
© 2008 Henry Chesbrough 11
What is an Open Business Model?
• Uses both internal and external sources to
create value
• Uses both internal and external sources to
capture a piece of that value
© 2008 Henry Chesbrough 12
Which Would You Rather Have?
• A Better Technology
Or,
• A Better Business Model
© 2008 Henry Chesbrough 13
Graphic Illustration of a Generic
Airline Business Model
Air Travel
Airport Aircraft, Fuel
Runway Checkin Jetway
Cleaning
Food
Passengers Revenue
Costs
© 2008 Henry Chesbrough 14
Ryan Air
• Ryan Air is a regional low-fare airline operating in
the United Kingdom and northern Europe.
• Only flies into regional airports, no landing fees.
• Guarantees airport certain # passengers in their terminal
• Airport pays Ryan Air to operate out of its airport
• Airport provides Ryan Air a percentage of the revenues
from shops, restaurants, car hire and hotels at airport.
© 2008 Henry Chesbrough 15
The Ryan Air Business Model
Air Travel
Airport
CheckinJetway
Parking
Shopping
& Food
Car HireHotels
Aircraft, Fuel
Cleaning
Food
Passengers
Revenue
X X X
© 2008 Henry Chesbrough 16
IBM: Its Closed Value Chain
Value-Added Activities
Materials
Chips, devices
Computers
Operating Systems
Applications
Productivity SW
Atoms
Solutions
Value Chain
All IBM – pre 1993
© 2008 Henry Chesbrough 17
IBM’s Open Business ModelValue-Added Activities
Materials
Chips, devices
Computers
Operating Systems
Applications
Productivity SW
IBM Chain OEM Market
Materials
Chips, devices
Computers
Operating Systems
Applications
Productivity SW
Integration
Atoms
SolutionsOther Integrators
© 2008 Henry Chesbrough 18
IBM’s Open Source Business Model
• Spends about $100M each year on Linux
– 50% for general improvement
– 50% for specific improvements for IBM gear
• Others spend another $800M a year
• IBM creates value through Linux
– Also donates development tools, patents
• IBM captures value through value-added services and software “up the stack”
© 2007 Henry Chesbrough 19
The Business Model
• Identifies a market segment
• Articulates the value of the proposed offering
• Focuses on the key attributes of the offering
• Defines the value chain to deliver that offering
• Creates a way for getting paid
• Establishes the value network needed to sustain
the model
© 2007 Henry Chesbrough 20
Business Model Maturity Stages
6 stages
1. Undifferentiated business model
2. Differentiated business model
3. Segmented business model
4. Externally aware business model
5. Integrated business model
6. Platform leadership business model
© 2007 Henry Chesbrough 21
Stage 1-Undifferentiated
• Commodity
• No differentiation
• Hard work, hustle, luck
• Can’t attract capital, can’t scale
• Example: most restaurants
© 2007 Henry Chesbrough 22
Stage 2-Differentiated
• Performance advantage
• Ad hoc processes
• Hard to sustain
• “one hit wonders”
• Example: most technology startups
© 2007 Henry Chesbrough 23
Stage 3 - Segmented
• Can serve multiple segments
• More profit, more volume (low cost)
• More sustainable
• Still too internally focused
• Example: many industrial firms; Xerox
© 2007 Henry Chesbrough 24
Stage 4 – Externally Aware
• Now harnesses external sources of
technology to complement internal
• More “at bats” with same dollars
• Share risks as well as rewards
• Broader market now available to serve
• Example: SAP R/3; Big Pharma
© 2007 Henry Chesbrough 25
Stage 5 - Integrated
• External sources routinely utilized to fuel your business model
• Unused internal ideas allowed to flow outside to others’ business models
• Company becomes a systems integrator of internal and external technologies
• Examples: Millennium, other biotechs; Nike; Procter & Gamble
© 2007 Henry Chesbrough 26
Stage 6 - Platform
• Ultimate stage, an ideal
• Company now benefits from investment of others in
the platform. Company can induce investment.
– Suppliers, customers, third parties
• Ecosystem created
– Company must balance value creation with value capture
– Cannot become predatory, destroys ecosystem
• Examples: iPod; .NET, WebSphere, Dell, WalMart
| 27|
Who Owns Business Model Innovation?
Marketing?
Research and Development?
Business
Unit GM
?
CEO/COO
?
Operations?
Corporate Strategy Office?
Business Development?
Finance?
© 2007 Henry Chesbrough 28
Why Business Models are Hard to Innovate: Mapping Across Domains
Technical
Inputs:
e.g.,
feasibility,
performance
Economic
Outputs:
e.g.,
value,
price,
profit
Business
Model
• target market
• value prop.
• key attributes
• value chain
• how paid
•Value network
Measured in technical domain Measured in social domain
© 2007 Henry Chesbrough 29
Type I and Type II: Xerox and PARC
�Designed to minimize “false positive” errors
�Ignores risk of “false negative” errors
© 2007 Henry Chesbrough 30
3Com
• Metcalfe left PARC in Jan. 1979
• Did consulting work until Feb. of 1981
– DEC, GE, Exxon
• Brokered alliance between Xerox, DEC,
and Intel for IEEE 802 (aka Ethernet)
• Initial plan: sell to Unix workstations, via
direct sales force
© 2007 Henry Chesbrough 31
Then….• As part of consulting, created directory of LAN dealers and VARs across US– first of its kind
– sold many hundreds of copies at $125 each
– did this for 5 years
• IBM PC took the world by storm
• 3Com formed, Krause joined from HP– VCs financed:
• New plan: add-on boards for IBM PCs, sold through IBM retailers and VARs
© 2007 Henry Chesbrough 32
Adobe
• Warnock and Geschke at PARC
– creating fonts for Star Workstation
– wanted to make into a standard
– Xerox said no: “how can we make money if we give it
away?”
• They leave, and form Adobe
• Initial plan: turnkey publishing system, complete
with own hardware, software, and fonts
© 2007 Henry Chesbrough 33
“We were originally going to supply a turnkey systems solution including hardware, printers, software, etc.
“Steve Jobs and Gordon Bell were key ingredients in getting things going…
Gordon said, “don’t do the whole system”
Steve said, “just sell us the software”.
That’s how the business plan formed. It wasn’t there in the beginning.”
- Charles Geschke
Today, Adobe’s market value exceeds that of Xerox
© 2007 Henry Chesbrough 34
Different Financial Processes
Chess: Type I errors
• Plan several moves ahead
• No new information needed
• You know what you’ve got, what opponent has
• NPV
Poker: Type II errors
• Pay to play
• Pay for new
information
• You discover what
you’ve got, what
other players have
• Options
© 2007 Henry Chesbrough 35
Xerox: Great at Chess, Lousy at Poker
0
5000
10000
15000
20000
25000
30000
35000
40000
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
Year
US Dollars (millions)
Xerox 3Com
Adobe Doc Sci
Documentum FileNet
Komag Objectshare
SynOptics SDLI
VLSI Sum (10)
© 2007 Henry Chesbrough 36
The Economic Pressures on Innovation
Closed
Model
Before
Internal.
Development.
Costs
Own
Market
Revenue
Revenues
Costs
0
© 2007 Henry Chesbrough 37
The Economic Pressures on Innovation
Closed
Model
Before
Own
Market
Revenue
Closed Model
After
Internal.
Development.
Costs
Own
Market
Revenue
Internal
Development
Costs
Shorte
r
Product L
ife
in th
e M
arket
Rising costs of innovation
Revenues
Costs
0
© 2008 Henry Chesbrough 38
The New Business Model of Open Innovation
Closed
Model
Own
Market
Revenue
Open Innovation
Business Model
Internal.
Development.
Costs
Own
Market
Revenue
Internal and
External Dev.
Costs
New
Revenues
Cost and Time savings from
leveraging External development
Cost
Revenue
Licensing
Spin-off
New Mkts
39