Open Innovation and Avoiding the Commodity Trap

Companies can no longer compete on hardware or products alone, global market forces are pushing even established industry leaders into the commodity trap. Berkeley Professor Henry Chesbrough, the “Godfather of Open Innovation,” says companies can stay ahead if they employ the open service innovation paradigm.

When Professor Chesbrough coined the term “open innovation” thirteen years ago, he codified a leading-edge approach to the corporate innovation process, a practice now internalized by GE, Samsung and many other titans of industry in the U.S. and abroad. Open innovation is the decentralized approach to corporate business model innovation which engages purposive inflows and outflows of ideas and information to facilitate new product innovation. Where many businesses in eras past used heavily guarded R&D within the firm, the open innovation process removes secrecy in favor of engaging multiple external actors to facilitate a company’s product innovation. By opening up the process and utilizing external actors -- such as customers, startups, other businesses on the supply chain, universities—businesses can improve upon or create entirely new business models quickly and efficiently.

Chesbrough’s open process for business model innovation has become de rigueur among companies seeking rapid innovation to stay ahead of the curve. But today, intense global competition, outsourcing and rising production costs have created a common pitfall that even the most innovative companies find themselves in; a conundrum Chesbrough calls “the commodity trap.”

“This trap is where you reach a point at which you cannot differentiate your product enough to earn a premium against competition,” says Chesbrough. This competition could arise from manufacturing competitors such as Chinese firms, which are able to mass produce products at much lower margins. “No matter how much you are able to innovate on your product, if you focus only on hardware or product innovation, you are constantly subject to the commodity trap.” 

Learn from Your Customers

How do leaders in competitive industries avoid this trap? “By paying close attention to their customers,” says Chesbrough. “You must still keep innovating and working on your costs. But getting out of the commodities trap involves truly understanding what your customers do with your products, which will give you insights into how you can do more with and for them.” Once the customer mindset and behavior is understood, leaders can build ingenious new services which support or enhance the product experience. This is what Chesbrough calls the “open services innovation paradigm.”

General Electric is an early example of a company which has adopted open service innovation by adding service-based business models to its portfolio. For instance, the company’s aircraft division sells jet engines with price tags in the tens-of-millions of dollars. Realizing the potential for outside competition to disrupt their margins, GE added a set of services which ends up being better for customers and for its own bottom line.

“What GE has done is continue to sell engines, but customers now have the option to rent ‘power by the hour’ services, which means they only pay per flying hour,” explains Chesbrough. For GE, all of the servicing of that the engine now becomes a paid service as part of the contract. “So GE makes more money but the customer gets a good deal too. Instead of putting all that cash up front, GE carries the asset on its balance sheet, and the customer only pays for what they use rather than sinking the cost all up front.” It’s a brilliant way for the company to better meet the customer’s needs and improve both bottom lines.

Dual Approaches to Open Service Innovation

Another example of open service innovation?  “Amazon does two wonderful things relevant to open service innovation,” says Chesbrough. First is the customer review system, which give other customers information and details about a product. Customer reviews have been shown to have enormous influence in purchase behavior and customer satisfaction. “Amazon doesn’t have to pay for this, they get all these valuable customer reviews for free. So we as consumers are enabled to make better purchase decisions, without it costing Amazon anything. That’s very cool.”

Amazon also launched an entirely new business model —Amazon Web Services—by packaging the same infrastructure it uses to store and process online transactions in the cloud and selling these services to businesses who want cloud computing functionalities. “Like the GE engine, customers only pay for the server capacity they use,” says Chesbrough. “So this has been a growth accelerator for Amazon a great value for other companies, and it shows how Amazon stays one step ahead of online retailers.”

Henry Chesbrough literally wrote the book—several of them—on open innovation, including: Open Innovation: the New Imperative for Creating and Profiting from Technology, Open Business Models: How to Thrive in the New Innovation Landscape; Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era, and New Frontiers in Open Innovation. Hear from one of the most sought after thought leaders on corporate innovation at the InFocus podcast, and from his executive program, Corporate Business Model Innovation, taught through UC Berkeley Executive Education.