Monday, July 5, 2010

What To Do When You Don't Know What To Do Next

When Procter & Gamble found itself running short of product ideas in the early 2000s, then-chairman and CEO A. G. Lafley began pushing the company to look outside for some fresh thinking. A full 50% of its innovations should be externally sourced, he said. P&G, meanwhile, wanted sales to grow by at least 4% a year, recalls chief technology officer Bruce Brown, the company’s point man on innovation initiatives, “and it was clear we couldn’t do all that ourselves.”

The board supported Lafley, now 62, even though doing so broke a longstanding tradition at P&G (and just about every other company, come to that) of keeping shortcomings and new-product strategies out of the public eye. Soon company managers were joining the scouts P&G already had in the field, trolling trade shows, venture capital forums, and pretty much anywhere else, letting it be known they were looking for nascent products and new ways to make and market them.

The Cincinnati-based consumer-products colossus formed partnerships with a number of small outfits, such as a Japanese company it encountered at a trade show that now produces an Asian-style Pringles snack. Other times P&G simply bought the means to make something itself, including a patented peptide technology developed by a small French firm it met at a European supplier conference that is now a key ingredient in Olay Regenerist, a new, best-selling anti-wrinkle face cream.

P&G also turned to the Internet, inviting a global community of scientists and weekend tinkerers to propose solutions to various problems it faced—or to offer innovations (that is, products and processes) of their own. One example: Syntopix, a small British firm, submitted an unsolicited proposal via P&G’s website that led to a deal in which the company supplies P&G with proprietary antimicrobial technology for use in various skin-care products.

Though less expensive than directly funding research and development, all this outreach still requires money and effort. P&G won’t supply specific figures, but it has invested in sophisticated Web portals that enable its people to interact with the outside world, trained some of its 9,000-strong R&D staff to manage the process, and added a special dealmaking organization to help individual business units negotiate contracts with outside contributors.
The investment is paying off. Organic growth at P&G has hummed along at 5% most years since 2001, when Lafley, who stepped down last year, pitched his idea to the board. (Former chief operating officer Robert McDonald, 56, took his place as CEO.) Today more than 50% of the company’s new products have what Bruce Brown calls “an external component,” a technology or other innovation generated by outsiders. “We think we’re getting access to about two million inventors and innovators around the world,” he says. “It’s key to how we grow.”

P&G is far from alone in embracing what’s known as open innovation. With R&D costs skyrocketing and new products and processes tougher to come by, even companies with deep research benches lack the internal know-how needed to solve every problem they encounter and keep their product-development pipelines full. Best Buy, Dell, Eli Lilly, and IBM are among the growing number of companies that regularly turn to outsiders for new ideas and technical help.

“Companies used to think they could hire the best people in the world, lock them in labs, and get the best innovation,” says Karim Lakhani, an assistant professor of technology and operations management at Harvard Business School. “That’s not the case anymore. The problems are so complex and knowledge is so widely distributed in society that no one organization has a monopoly on ideas.”

It’s a trend that demands board attention and oversight, particularly given the cost-cutting benefits of open innovation in today’s unforgiving business environment. It also represents a dramatically different way of achieving corporate objectives, one that is beginning to give its adherents a competitive advantage. Ultimately it has the potential to speed along a redefinition of the corporation from a stand-alone entity into a locus for a series of supplier, partner, and customer relationships.

While companies have long indulged in joint ventures and the like, the Internet has accelerated the need for outside thinking. Eli Lilly, the Indianapolis harmaceutical giant, regularly contracts with small firms in China and India to develop compounds that become part of new drug products. Lilly also partnered with Daiichi Sankyo Co., a Japanese pharmaceutical company, to develop Prasugrel, an antiplatelet drug for patients with acute coronary disease that is now on the market.

The pharmaceutical industry is under huge pressure to fill development pipelines, and even Big Pharma companies can’t do that on their own, says Lilly director Alfred Gilman, 68, chairman of the board’s three-member science and technology committee. (The other two are J. Erik Fyrwald, 49, chairman and CEO of Nalco Co., an Illinois maker of water-treatment products, and Franklyn Prendergast, 63, a professor at Mayo Medical School in Rochester, Minnesota.) “A lot of the interest is economically driven, but it’s mostly about talent,” says Gilman, who is chief scientific officer of the Cancer Prevention and Research Institute of Texas, which helps fund research projects. “We need to reach out and find the best ideas wherever they are.”

Netflix, the Los Gatos, California, movie-rental outfit, also did some reaching out in order to improve its Cinematch recommendation system, which uses customers’ rental histories to suggest other films it thinks they will like. The system already scored well with Netflix’s busiest renters, 90% of whom said they liked the recommendations. Netflix aimed to raise that satisfaction level by 10% and in 2006 announced a global online competition to find a better forecasting algorithm. It posted a sample of more than 100 million customer ratings for techie contestants to play with, and offered $1 million to whoever could hit the improvement target first.

“We wanted to make the best better,” says vice president Steve Swasey. “By throwing the challenge open in a worldwide contest, we got thinking from some of the best computer scientists in the world, and it cost us relatively little. We could never have afforded that much talent and work internally.” Three years and 40,000 entries later, Netflix announced in September that it had a winner: a seven-person team of software and electrical engineers, statisticians, and machine-learning researchers from Austria, Canada, Israel, and the U.S. The winners, who had started off as members of different teams and then got together online, came up with a solution that plugged that missing 10%.
The Netflix contest was the brainchild of CEO Reed Hastings, 49, “but it wouldn’t have happened without the board’s support,” Swasey says. The company has since launched another $1 million contest to improve its recommendations for more sporadic movie renters, this one using demographic information.

Not every company wants to advertise its needs or shortcomings quite so publicly, nor are many ready to invest the millions it can take to set up Web portals and train people to operate a direct online solicitation. Enter a growing legion of middlemen, outfits that hook up companies (anonymously, if that’s what they want) with individuals or groups that might be able to solve specific problems. InnoCentive, based in Waltham, Massachusetts, has a network of some 180,000 “solvers,” about 60% of whom have master’s degrees or Ph.D.s, says CEO Dwayne Spradlin, 43, though “anyone in the world is free to join.” They can visit the business’s website to check out the challenges posted on behalf of various companies—“seekers,” in open-innovation parlance—and the rewards being offered. InnoCentive, which takes a 40% cut of the winnings, claims a success rate of about 50%. Colgate-Palmolive used the company’s site to offer $25,000 to anybody who could dream up a better way to inject fluoride powder into a tube of toothpaste.

A few weeks later a Canadian hobbyist with a background in physics suggested imparting an electrical charge to the powder and grounding the tube. He won the reward, and InnoCentive collected its cut.

Other middleman organizations work in pretty much the same way. TopCoder, a Glastonbury, Connecticut, company, helped Lending Tree, an online mortgage originator, build its website, posting the specs of what the financial concern wanted on a site open to a global network of 225,000 software writers and graphic designers. Lending Tree also uses TopCoder to conduct regular “bug races,” in which it pays sums that can run from $10 into the thousands to the first techies who can sniff out and repair recently discovered software bugs. “It’s find it and fix it. Whoever does it first gets paid,” says TopCoder CEO Jack Hughes, 48. “This marks a significant shift in how companies get work done.”

It’s also cheaper. Lending Tree would need to employ a whole team of experts to address the thousands of small glitches TopCoder’s techies have identified and fixed. Relatively low costs have enabled some smaller companies to innovate on a shoestring. Example: SunNight Solar LLC, a tiny Houston manufacturer of solar-powered flashlights for the developing world that wanted to make an affordable solar-powered device capable of lighting a whole room. Mark Bent, 52, SunNight’s founder and CEO, took the problem to the InnoCentive site, offering a $30,000 reward to whoever came up with the best idea. After culling more than 40 viable responses, he picked a design from a New Zealand engineer that combines a polycrystalline solar panel, an environmentally friendly rechargeable battery, and high-efficiency light-emitting diodes. “Getting access to that wealth of talent from around the world is a game-changer for a company like ours,” he says.

There’s no other way we’d be able to do it.” The company is now making solar-powered room lights that sell online for $39; nonprofit organizations pay less. Boards eyeing open innovation need to be aware of potential pitfalls. One big worry: Who actually owns an idea submitted over the Internet? And how can a company make sure that a competitor doesn’t steal an idea floated in an open forum?

Many companies, including P&G, try to protect their intellectual property by breaking down their needs for large projects into smaller components to disguise the targeted, complete-picture outcome. Middlemen can also help on this front. InnoCentive posts specific needs and will protect a client company’s identity if asked to. It also requires its solvers to sign nondisclosure agreements and transfer all their rights in their ideas to the seeker, including the right to develop derivative products, says CEO Dwayne Spradlin. InnoCentive offers various protections to its solvers as well.

Open innovation may ruffle the feathers of a company’s in-house R&D teams, whose members might well feel threatened and could try to block or sabotage it. P&G’s department heads and developers were initially “incredulous that this could work,” recalls CTO Bruce Brown. “We’re a company that had incredible success developing things internally. Getting people to believe it could be done differently and still win was a major challenge.”
To overcome such resistance, some companies start small, by encouraging more idea-sharing among internal business units. They also work to get in-house researchers to think of themselves “less as inventors and more as managers of networks of outsiders involved in the innovation process,” says TopCoder’s Jack Hughes. “The No. 1 issue is change-management—getting people acclimated to the idea that the old ways are being replaced.”

That’s where the board’s commitment to doing things differently is critical. “You can’t just throw things out there and think you’re going to get cheap labor,” Harvard’s Karim Lakhani says. Doing open innovation right “requires money and management and board attention. There has to be a top-down mandate.”

And the board has to stay involved. At Eli Lilly, the science and technology committee meets regularly with management to “discuss the nitty-gritty of things in the pipeline or a new approach to a technology or outsourcing in China,” says committee chairman Alfred Gilman. That level of involvement signals to the workforce just how important open innovation is to the company’s strategy. At P&G, the board’s six-person innovation and technology committee helps oversee all kinds
of development, including the so-called connect-and-develop program. Headed by Ralph Snyderman, 69, chancellor emeritus of Duke University, the committee also comprises Scott Cook, 57, chairman of the executive committee at tax-software maker Intuit; Rajat Gupta, 60, a senior partner emeritus of McKinsey & Co., the consulting corporation; Lynn Martin, 69, a former professor at Northwestern University’s J.L. Kellogg Graduate School of Management; Johnathan Rodgers, 63, CEO of TV One LLC; and Ernesto Zedillo, 57, former president of Mexico.

P&G’s committee members have gotten involved in some demanding exercises, such as figuring out how to create metrics to measure the success of open-innovation projects. “They push me really hard on this,” says Bruce Brown. “They’re asking, are we sure we’re getting access to the best technologies? And when ideas come into the system, are we truly open to evaluating them objectively?” The committee—and the full board—leave him to make his own final calls. Nevertheless, this kind of board-level attention has gone a long way toward helping to “create a culture that values innovation and is self-confident enough to look outside to get it,” Brown says. “The board has really walked the talk on its commitment to doing this.” In the end, shareholders could be the primary beneficiaries.
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