A Buyer’s Guide to the Innovation Bazaar
Reprint: R0706H
Companies seeking new ideas or product concepts from outside sources may find the “innovation bazaar,” with its wide array of choices and methods of acquiring them, a confusing, chaotic place. Nambisan and Sawhney have crafted a conceptual guide for managers who understand the importance of going outside their firms for innovation but are uncertain about how to do it.
The authors’ “external sourcing continuum” shows at a glance how shopping for, say, raw ideas compares with shopping for market-ready products in terms of cost, risk, multiplicity of options, and speed of commercialization. Raw ideas, whether acquired directly from the inventor or through a patent broker, licensing agent, or some other intermediary, tend to be low cost but high risk and take a long time to bring to market. Market-ready products, often acquired as stand-alone businesses through a venture capitalist or business incubator, are more expensive and narrow one’s choices, but they can be launched quickly and with less risk.
Between these two approaches lies a third, facilitated by the “innovation capitalist.” This new kind of intermediary provides client companies with access to a broad range of innovative product or technology ideas that are nearly market ready, thereby mitigating early-stage risks and lowering the time to market without significantly increasing acquisition costs.
The authors compare the advantages and disadvantages of using intermediaries associated with the three approaches and provide a checklist of factors to consider when placing your company on the external sourcing continuum. If you’ve been oriented toward one end of the continuum or the other, you can increase your options and your flexibility by expanding into the middle.
As companies discover the tremendous value to be gained from tapping into external sources of innovation, many seek to emulate the success of some particularly compelling and well-publicized initiative. It might be Procter & Gamble’s Connect + Develop, in which the company uses online R&D marketplaces and other intermediaries to identify and acquire ideas and technologies from independent inventors; or Intel Capital, through which the chip maker invests in technology start-ups and spurs innovation that enriches its business ecosystem overall; or Concept Lounge, an interactive forum set up by Nokia to find and acquire innovative and futuristic product concepts directly from independent designers.
But to seize upon one of these successful programs as a model is to misunderstand how to source innovation from outside your organization. There is no single best method for doing this. Numerous useful approaches—each with different attributes and benefits—are on offer in the global marketplace for new ideas, products, and technologies.
We call this marketplace the “innovation bazaar.” Like a traditional bazaar, it can be chaotic and bewildering. The dizzying array of wares ranges from raw ideas and patents to market-ready new products. And they are touted by all kinds of hawkers, from idea scouts to business incubators. Just contemplating a plunge into the hurly-burly of this space can be daunting.
Indeed, our conversations with senior managers at more than 30 major corporations suggest that although most companies have come to understand the importance of looking outside for innovation, they have serious misgivings about how to do it. The success stories notwithstanding, smart executives know that what works for a P&G or an Intel may not be appropriate for a DuPont or a Microsoft. But how should they shop for the innovation offerings that will work for them?
We offer here a conceptual guide to navigating the innovation bazaar and making wise selections from the various vendors. With this guide in hand, companies can meet their particular needs by putting together a balanced mix of offerings based on the external market context and their internal capabilities. We also introduce a new kind of intermediary that can help companies improve the effectiveness of their innovation sourcing efforts.
We have organized the possibilities for externally sourcing innovation along a continuum defined by four variables: the reach that companies have as they cast about for innovative ideas to assess; the cost of acquiring and developing those ideas; the risk involved in trying to turn them into marketable products; and the speed with which the ideas can be brought to market. (See the exhibit “The External Sourcing Continuum.”)
Companies can shop for innovation in various stages of development—from raw ideas to market-ready products—with the help of a variety of intermediaries. At the two ends of the continuum, however, there are trade-offs: Sourcing raw ideas costs less and allows a company to increase its reach (the number of options it is able to consider) but involves higher risk and a longer time to market. The reverse is true for acquiring market-ready products. The middle of the continuum offers balance among the four factors.
Let’s begin with two clearly distinct alternatives for strengthening the innovation pipeline outside your organization. You can shop for relatively undeveloped ideas or patents and then invest in their development and commercialization. Or you can shop for products, concepts, and technologies that have been developed into market-ready offerings. These alternatives—which often require the involvement of an intermediary—define the two ends of our continuum. The unexploited middle holds a third alternative, which we will explore below.
One approach to sourcing innovation is to reach out directly to independent inventors. Consider the Partners in Innovation initiative launched by Dial, the makers of Dial soap, Purex laundry detergent, and other consumer products. The initiative originated as a Web site where inventors could submit patented ideas that Dial would then evaluate for commercial potential. In 2004 Dial, a subsidiary of the German manufacturing conglomerate Henkel, expanded the initiative with a contest for independent inventors called “Quest for the Best.” Contestants were invited to submit patented (or patent-pending) ideas in certain product categories. The company worked with the United Inventors Association, a national body for independent inventors, to publicize the contest and give it credibility in the inventor community. A panel of judges within Dial screened the hundreds of submissions and narrowed them down to 60. Each of the semifinalists was then allowed to pitch his or her idea in a five-minute video that focused on how it might lead to a product different from and better than existing ones. Dial chose ten finalists and invited them to its corporate campus to present their ideas to senior executives. Three of the ten ideas were selected as winners and given a more formal market evaluation and feasibility analysis. In the end, Dial identified one or two as commercially attractive and well suited to its product portfolio.
Dial has continued with the contest, and several of the winning proposals, in categories ranging from personal care to household goods, are currently working their way through the company’s product development pipeline. But Dial got more than some potential products. By working directly with the inventor community—for whom its motto was “Think of Dial first”—the company also established itself as a preferred portal for new ideas.
Looking for independent inventors with marketable ideas can be a needle-in-the-haystack quest. Many companies, to improve their reach and their filtering process, rely on innovation intermediaries to find inventors. These include idea scouts, which seek and screen ideas in the inventor community on behalf of large firms that then review them for commercial potential; patent brokers, which bring together inventors and firms that are interested in commercializing their patents, without representing either side; licensing agents, which broker the licensing (rather than the sale) of patented technologies; and “invention capitalists” (a term used by Microsoft’s former chief technology officer Nathan Myhrvold), which buy patents from inventors and then sell them to companies, sometimes bundling patents related to a particular market opportunity. In addition, electronic R&D marketplaces, such as InnoCentive, NineSigma, and yet2.com, can help match companies with promising ideas or patents.
Staples, the office-supplies retailer, has effectively employed intermediaries in its search for inventions. Over the past few years the company has been aggressively repositioning itself as an innovator of its own private-label products rather than merely a reseller of others’ branded or generic products. Realizing that it lacked internal innovation capabilities and that developing a large internal product development organization would take too much time and effort, the company engaged the idea scouts Big Idea Group and Product Development Group to identify promising ideas for commercialization, usually related to a particular theme or market (for example, filing and note-taking products) specified by Staples. The scouts are paid up front to conduct the idea hunt and may also receive a share of the royalties paid to the inventor when an idea is turned into a branded Staples product. The process has yielded numerous products, including a distinctive new line of file folders and a padlock that employs letter rather than number combinations, so that it can be unlocked by a word.
By shopping for ideas, either directly with inventors or through intermediaries and electronic marketplaces, companies increase the range of ideas available for consideration. They typically return from such a shopping expedition, however, with ideas or patents that are a long way from being market ready. In such cases the significant market and technology risks can be mitigated only by further development and market testing. Companies may also need to spend considerable time and effort addressing scaling issues that crop up further along in development, such as whether a product can be manufactured cost-effectively in large quantities. If the aim is to respond rapidly to market demand by introducing new products—well, you’ll have to be content to hurry up and wait.
If your aim is to respond rapidly to market demand with new products, shopping for raw ideas means you’ll have to be content to hurry up and wait.
At the other end of the external sourcing continuum, companies can buy products or technologies that are ready for launch, often by acquiring not just the product but the company that developed it. Like the acquisition of raw ideas, this approach can be taken with or without the help of intermediaries—for example, venture capitalists or university-affiliated business incubators—that invest in or nurture new ventures with the aim of readying them for acquisition by large firms.
A classic example of this is Procter & Gamble’s tremendously successful 2001 acquisition of the SpinBrush Company, makers of a low-cost battery-operated toothbrush, from Nottingham-Spirk, a small product invention and development group. P&G acquired a fully developed and market-tested product, meaning lower innovation risk and faster time to market—but it had to shell out $475 million for SpinBrush.
Relying exclusively on this approach also limits your options, because few ideas get far enough along the innovation pipeline to be market ready. Furthermore, when a company acquires a firm as well as a product, it may find that it doesn’t need the routes to market, the sales organization, or the rest of the commercialization infrastructure surrounding the product concept; in fact, these may have to be discarded at a cost.
Even so, many large companies have traditionally acquired single-product entities in order to source innovation externally, particularly within the consumer products and technology sectors. For example, Unilever and DuPont, among a number of others, have internal new-ventures groups that scan the external environment for investment and acquisition opportunities to complement their existing portfolios.
Some technology companies, particularly in the software sector, have sought market-ready products or businesses without the help of intermediaries—for example, by creating captive marketplaces or offering in-house incubation services for external ventures. By providing a platform and the resources for start-ups or independent innovators to develop and sell their product ideas, these companies can attract and get a close look at innovative concepts or businesses they might wish to acquire. Salesforce.com, a leading player in enterprise software applications for customer relationship management, has adopted both the marketplace and the incubation approach.
In January 2006 Salesforce.com created the AppExchange, an online marketplace for software products from external developers that would complement the company’s own products. The AppExchange currently lists more than 500 on-demand applications—in areas ranging from finance to human resource management—which Salesforce.com’s customers can find, try out, and acquire from the independent developers, much as users browse the iTunes Web site to sample and buy songs. The company calls the AppExchange an “eBay for on-demand business software.” But the AppExchange is more than just a service for customers of Salesforce.com; it allows the company to identify attractive acquisition targets that would fit well into its core CRM product. Because it operates the exchange, Salesforce.com can track how often the applications are downloaded, what they sell for, and which ones get good reviews.
For example, in 2006 Salesforce.com acquired Kieden, a four-person company that had created an extremely popular add-on software that helps marketing managers analyze Google-driven Internet advertising campaigns and resulting sales leads. Kieden was able to develop a public beta version of the application and launch it on the AppExchange, where the number of downloads clearly demonstrated its strong market appeal.
Recently Salesforce.com launched another initiative—the AppExchange Business Incubator—to cultivate and promote the innovation activities of its complementary application developers. Although the company doesn’t invest in the businesses, it provides facilities to house them. The first AppExchange incubator was opened in January 2007 in San Mateo, California, near the company’s San Francisco headquarters. Partner companies rent space there for about $20,000 a year, gaining access not only to communications and other infrastructure but also to technical support and business and marketing guidance. The primary goal of this initiative is to encourage companies to develop applications that complement Salesforce.com’s core technology platform, but it also gives the company further opportunity to cherry-pick innovative applications for future acquisition.
These various means of buying market-ready or market-tested ideas—whether directly, through your own incubators, or indirectly, through venture capitalists and other intermediaries—have trade-offs that roughly mirror the trade-offs involved in acquiring raw ideas. The speedier time to market and lower innovation risk come with higher acquisition costs and a narrower range of options for consideration. These trade-offs may be acceptable in some contexts—particularly if a company is looking to quickly increase revenue or enter a new market—but they may be unnecessarily expensive in others.
The two approaches to external sourcing that we have examined so far offer companies a choice between raw ideas and fully baked products or companies. Depending on your situation, raw ideas may be too risky and fully baked companies may be too costly. A third alternative, which marries the benefits and reduces the drawbacks of the first two, falls in the middle of the external sourcing continuum.
Let’s briefly explore the cooking analogy. To get yourself a meal, you can buy the raw ingredients and cook them or you can order the meal already prepared from a restaurant. Starting from scratch costs less and offers almost infinite possibility, but it takes significant time and effort. Moreover, there is no guarantee—at least for most cooks—that you will end up with a tasty meal. Ordering a meal ready-made avoids the effort and the risk of cooking and usually requires only a short wait. But it costs a lot more, and your choices are limited to what’s on the menu. Recognizing these trade-offs, supermarkets now offer a fairly wide array of “step-saver meals” that leave the customer just a few simple tasks away from a nice meal that can be enjoyed at modest cost and with relatively little effort or uncertainty.
Similarly, a step saver is emerging in the innovation bazaar. It is enabled by a new kind of intermediary—the “innovation capitalist”—that differs from both the invention capitalists on the left end of the continuum and the venture capitalists on the right. Innovation capitalists can obviate the trade-offs typically inherent in outsourcing innovation.
Innovation capitalists operate in three stages:
In the first stage the IC firm draws on its well-established relationships in inventor communities to identify and assess product concepts or other ideas with commercial potential. In contrast to the idea scout, which often puts on road shows for inventors, the innovation capitalist looks for promising opportunities through word of mouth and chases down the inventors behind them, frequently providing an on-the-spot assessment that the inventor can use to go back and improve on an idea.
In the second stage the IC firm, after negotiating with an inventor to acquire partial ownership of an idea, will spend its own money to develop and transform the idea into something that can be evaluated for manufacturing feasibility and commercial potential. In this assessment the innovation capitalist will typically draw on its own deep industry knowledge and maintain a sharp market focus. The extent to which the idea needs to be massaged will vary greatly, depending on its nature, on the nature of the industry or market, and on the nature of the likely client company.
After acquiring partial ownership of an idea from an inventor, the innovation capitalist spends its own money to develop the commercial potential.
Consider a project that one IC firm, Evergreen IP, pursued recently. An inventor brought in an idea for a collapsible plastic trash collector to be used in temporary situations such as parties, picnics, and community events. Although the concept was promising, the initial evaluation showed that it wasn’t economically feasible. Evergreen funded some in-depth consumer research and concept work and realized that the inventor had identified a little-noticed problem that translated into a $250 million product opportunity—even though the proposed solution wasn’t the best way to tap into it. So Evergreen invested in efforts to substantially revamp the concept and make it commercially attractive. The resulting prototype has attracted serious attention from several large manufacturers.
In the third stage the IC firm will offer the fully developed product concept to one or more interested companies—preferably ones with which it has an ongoing relationship. This stage requires a sophisticated understanding of the target companies’ needs and capabilities along with expertise in the management and reasonable allocation of intellectual property rights.
For example, IgniteIP, another IC firm, recently assessed a new technology for removing heavy metals from water, which could reduce hazardous waste in the mining industry. The inventors had tried unsuccessfully to create a new business around the technology. When Ignite took over the project, it evaluated the market and decided that the greatest challenge lay in overcoming the mining industry’s inertia around adopting a new technology like this. So, in addition to modifying the technology to clarify its potential, Ignite constructed an innovative licensing scheme that provided sufficient incentive for a client company to acquire the new technology and also ensured that Ignite and the inventors would receive sufficient return on their investment.
Innovation capitalists attempt to optimize the four variables—reach, cost, risk, and speed—that define the external sourcing continuum. They provide client companies with access to a broad range of innovative product or technology ideas that are nearly market ready, thereby both mitigating early-stage innovation risks and lowering the time to market without significantly increasing acquisition costs. In return, they expect a share of the revenues that client companies get from commercializing the new products.
As we have seen, differences among the three basic approaches to innovation sourcing are reflected in the nature of their associated intermediaries. (For a detailed comparison of the three kinds of innovation intermediaries, see the exhibit “The Differing Roles of Innovation Intermediaries.”) For example, unlike idea brokers and some other early-stage intermediaries, which charge fixed fees for their services, innovation capitalists share with the inventor royalties on revenue generated for the company that acquires the innovation. They want compensation proportional to the value they have added to the idea. Unlike venture capitalists and other late-stage intermediaries, however, IC firms don’t add value primarily in the form of capital investments. (Although they do typically invest five- and six-figure sums in their projects, the money is used to refine the product idea rather than to build an organization or a management infrastructure around it.) Instead they contribute a unique combination of industry, market, networking, and innovation management skills, and they assume some development risk.
To acquire innovations along the external sourcing continuum, companies can engage intermediaries with different characteristics and roles.
But for companies considering the three approaches and the intermediaries that enable them, perhaps the most important difference—which may not be immediately obvious—is the nature of their interactions with the intermediaries. Companies seeking innovation at the two ends of the continuum focus primarily on the type of innovation they want to buy, whereas in the middle they need to focus on the intermediary. That is, because of the nature of the innovation capitalist’s offering, large client companies need to build and nurture long-term and trusting relationships with selected IC firms.
Such relationships ensure that each partner is aware of the other’s decision criteria and processes, making for smoother negotiations in product or technology commercialization deals. Furthermore, the client company can tacitly agree to give all the innovation capitalist’s proposals serious consideration in return for the first look at new ideas. In other words, the company should aim to become the preferred portal for the IC firm and its inventor community—much as Dial was for its own inventor community.
Client companies should provide IC firms with direction and guidance—for instance, by sharing information about product gaps, innovation priorities, and business goals. Pfizer Consumer Healthcare (now owned by Johnson & Johnson) makes its “external scan target map,” which plots brand growth opportunities, available to its sourcing partners. P&G provides a more direct “here is what we are looking for” list of priorities. Knowing the client’s goals enables the innovation capitalist to match them with promising ideas and concepts from its inventor networks and to evaluate those ideas in terms of the client’s market size, profit margins, and commercialization infrastructure. As the founder of one IC firm says, getting the green light for a new project is all about understanding the client’s “brand window” (that is, the gaps and priorities in the company’s brand portfolio) and “internal hurdle rate” (the expected returns required for a project’s approval). More generally, understanding the client’s internal processes and competitive context helps the IC firm to offer value that complements rather than duplicates the client’s capabilities.
In the words of David Duncan, the head of R&D for Unilever’s home and personal care division, at best such relationships offer more than a pipeline of new projects and become “a collaborative effort at building the innovation capability” of a client company.
It is also important that a large client company educate its internal units—particularly R&D—about the unique role of the IC firm. This may help overcome the “not invented here” syndrome. And integrating the innovation capitalist’s front-end work with the company’s back-end internal development can further reduce time to market and enhance success rates. For example, one of the IC firms we have studied adopted systems and tools for product concept evaluation that were already being used by its preferred client, allowing faster handoffs of projects between the two.
A large company can strengthen its relationship with an innovation capitalist partner by adopting a “reverse flow” model in which the company becomes the source of innovative ideas for the IC firm. Often, large companies have developed product or technology concepts—sometimes all the way to working prototypes—that sit on the shelf because they don’t fit strategic or market priorities. An IC firm can build on such concepts and market them to other interested companies.
Procter & Gamble’s external business development group recently initiated such a project. The company had developed a product concept but determined that the value of the target market was between $35 million and $50 million—well below P&G’s internal threshold. Since the concept required further work, P&G negotiated a deal with an innovation capitalist to develop and market it elsewhere. In addition to potentially generating revenue from unused assets, a deal like this helps cement ties with an IC firm and ensure that the company will get first refusal for interesting and relevant ideas from the firm’s inventor community.
Precisely because they are new on the scene, innovation capitalists are still refining their business models and thus must iron out some wrinkles. For example, they get much more modest returns than do, say, venture capitalists. That means they need enough ongoing projects in their portfolios to sustain the business. But an overlarge portfolio will reduce the value an IC firm can add in developing any given idea and also threaten its relationships with both client companies and the inventor community. Despite such caveats, it is worth companies’ time and energy to explore this new kind of relationship, given the potential benefits.
Before you can select the mix of innovation sourcing options appropriate for your organization, you must consider both your industry or market profile and your company’s internal innovation profile. (See the exhibit “Choosing Your Innovation Sourcing Strategy.”)
The innovation sourcing strategy or strategies most appropriate for your company are indicated by where you fall in the grid below relative to a number of external and internal factors. If most of your responses cluster in one column, you may want to focus on one particular strategy. If they scatter across two or three columns, you may want to broaden your range.
The left end of the external sourcing continuum is attractive to consumer products and other markets in which companies tend to have lots of small and diverse products, and innovation tends to be incremental in nature. Here independent inventors can work with limited resources, quite often coming up with concepts that are not radically new but, rather, enhance existing products. As long as the patents related to such ideas are enforceable, companies can acquire them outright from the inventors and pursue their own development and commercialization plans, as Dial and Staples have done. This end of the continuum also requires that the acquiring companies have the ability to develop raw ideas into products and an appetite for the risk inherent in such development.
The right end of the continuum is more appropriate when domain expertise, significant capital, and market validation are needed. Companies that rely on science- and technology-based competitive advantage, such as DuPont and 3M, tend to favor this end. New products for these companies take many years and tens of millions of dollars to develop—putting them beyond the reach of “garage entrepreneurs.” Thus DuPont relies on innovative companies that have already invested significant human and financial capital to develop market-ready products. Companies seeking innovation on this end of the spectrum will often be those with strong brands and commercialization capabilities but a low tolerance for the risk associated with developing an idea from scratch.
While every company must find its own center of gravity on the continuum, it need not rely exclusively on one intermediary or approach. For example, companies that typically favor idea scouts may seek more-mature ideas from IC firms. Similarly, organizations that have traditionally focused on acquiring innovative companies may discover that partnership with an innovation capitalist broadens the range of ideas they can consider without hampering their ability to respond to new market opportunities. For example, DuPont may find that buying companies is appropriate in its mature core businesses, such as building and construction materials, but alternative points along the continuum are useful for emerging businesses, such as electronics and imaging or bio-based materials.
Companies are oriented to one end of the continuum or the other for good reason. But expanding into the middle will increase both their options and their flexibility. No longer beset by anxiety and confusion, they can return home with a valuable and varied shopping basket after a visit to the innovation bazaar.
A Buyer’s Guide to the Innovation Bazaar
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