Q: What led you to realize the importance of business innovation?

A: I am a recovering disk-drive industry retread. I worked in the computer industry in the 1980s, primarily with [disk-drive vendor] Quantum. In being a part of its growth and seeing all the excitement there, that's probably where these ideas first were born.

The second thing that happened was I saw that while IBM created so much of the fundamental technology for our industry, the company seemed to have a hard time capturing value from all the research it was doing. (As you may know, IBM recently sold its disk business to Hitachi.) I wondesred why IBM was having so much trouble taking its technology lead and turning that into a lead in the marketplace.

Q: In your book, you say that innovation differs from invention. How so?

A: That's an important distinction. I think of invention as new discovery. It could be new to the world or new to the industry, but it's things we didn't know before. Invention is done by people who have scientific training or who are answering questions like why and how. They're asking difficult, long-term questions that result in fundamental new knowledge.

Innovation, by contrast, is applying knowledge to a real problem and taking an idea to market. There may not be any customer in mind during a process of discovery and invention, but a customer is critical to the process of innovation.

Q: What is open innovation, and how does it differ from closed innovation, which is what you say most companies do?

A: The basic idea is that in closed innovation, the model is one of discovering things yourself, then transferring them into development, production, distribution, service, and support within the four walls of your company. The logic is: If you want something done right, you've got to do it yourself.

But the idea behind open innovation is that there are too many good ideas held by people who don't work for you to ignore. Even the best companies with the most extensive internal capabilities have to take external knowledge and ideas into account when they think about innovation. So good ideas can come from outside as well as inside. And they can go to market not only inside your company, but also outside, through others.

Q: The subtitle of your book states that open innovation is the "new imperative." Why don't the tried-and-true methods of innovating work anymore?

A: They did work very well for a long time and in a number of industries. It's the very success of the old way of doing things that accounts for its persistence today. Many people still consider Bell Laboratories to be the pre-eminent industrial research center in the world, and certainly in its heyday, it won an enormous number of Nobel Prizes and other scientific achievements. It made a lot of money, too, for the parent company. The reason that worked very well is that AT&T had a monopoly: It didn't have any effective competition that could pilfer ideas from Bell Labs and take them to market. The competition would essentially wait until the technologies were already out of the laboratories to go into the market.

Of course, the scientists doing this work really didn't have many other places they could go to ply their craft. So the whole thing was a virtuous circle: As more technology came out, new products and services would be created; those would go to the market and create new revenues and new profits, which could be reinvested. So whether it was General Motors in the automotive industry, DuPont in the chemical industry, or AT&T or IBM in the computer industry, the companies that did the most research had the highest market share, the highest profits, and were able to reinvest and keep it going. It really did work very well for a long time.

Q: What's changed?

A: A few things changed. I'm not sure about the rank order of these, but one of the biggest ones is that people's mobility increased a great deal. People started jumping from job to job, rather than working for one company their whole career. Another: Venture capital became a huge deal, and that helped fuel people's departure. Then, the university system got a lot better, in terms of the research and the relevance of the research. More and more useful ideas were coming out of universities directly, as opposed to R&D laboratories only.

These things gave rise to distributing knowledge very widely, to organizations, large and small. As a result, now there is a lot of good knowledge all over the place, and no company has a monopoly on useful knowledge the way AT&T did in communications or IBM did in the computer industry.

Q: Does that mean the age of the large R&D department is over?

A: The way we talk about research has to change, and if the laboratories don't adopt a new approach to research, then I think they're doomed. Of the things that have to become a key focus, one is to be much more externally aware and externally focused before you undertake internal projects. You want to take internal projects in hand to fill a gap that's not being addressed outside or to put the pieces together in new combinations in systems or architectures that are very useful. That's where the value will now be in research. It's not going to be in just discovering a neat new building block, but in finding ways to combine the building blocks that are out there into new combinations.

But that's not how we train our scientists and engineers in our universities right now. It's also not how we reward and promote people in most of the R&D laboratories. To make this work well, we've got to do some work both on how we train our R&D staff and then on how we hire and promote them.

Q: We've been discussing the vendors. What does open innovation mean to the business-technology executives who use IT?

A: It applies very much to them. A company I talk about in the book is Procter & Gamble, which just signed a big outsourcing deal with Hewlett-Packard. P&G was trying to find new ways to increase its growth as a company, and it had done about as good a job as you could do growing its current brands. To get any additional growth, it had to find a way to create new brands to solve new needs. Through A.G. Lafley's leadership as CEO, it's been trying to get much more externally focused to create and access those new brands.

To that end, P&G has set a corporate goal: If it's getting about 10% of its ideas from outside its organization today, in five years it would like that number to be 50%. The other thing P&G has done is to institute a policy that any technology P&G develops that's not being used by one of its businesses within three years will be made available to license to all comers, including competitors. So if P&G businesses don't run with the technology that P&G develops--if they don't use it--they could lose it. The focus there was to try to stimulate additional growth.

Q: Was this accompanied by organizational change at P&G?

A: Yes, in fact, it had to change CEOs. It doesn't come easy; there's a lot of internal organizational resistance. You can understand why: The good scientists and engineers in your company have a natural preference for their own stuff. They know where it came from; they know where it's been; and they know the people who developed it. So there's a confidence factor that isn't there when you're talking about bringing in somebody's stuff from outside. So naturally they tend to undervalue the external technology, and, maybe implicitly, overvalue the stuff they're doing themselves, in terms of how long it will take to do, how much it will cost, and so forth. You've got to be prepared to meet those objections and deal with them.

One thing P&G did to cope with that is to take some of its internal R&D staff and turn them into external technology scouts. So it's not a bunch of new people brought in from somewhere else. That helps a great deal. Then these policies--like the use-it-or-lose-it policy--change mind-sets, too, because now when a new technology shows up, the businesses have to think a little harder before they say no. Before, if they said, "No, it's not ready yet. Keep us posted," all that would happen is, it would sit on the shelf, and it would be revisited in six or 12 months' time. Now there's a possibility that, instead of it just sitting on the shelf, it might actually go outside. If somebody else finds something valuable to do with a technology that you passed on, there could be consequences.

Q: In your book, you say business models are critical to innovation. Why?

A: This gets back to the distinction between invention and innovation. Discovery, or invention, is really about creating fundamental new knowledge. Your question wouldn't apply there, but when you get to innovation-to try to unlock economic value from technologies-my argument is that a technology without a business model is worth very, very little.

A business model is a way of thinking about how you connect technologies and their possibilities to things that customers care about and will pay for. I step through six different elements of a business model to help people in the R&D community think about business models and, likewise, to help people in sales and marketing ask: What is our business model in this area? And how can we articulate the needs of our customers and markets in ways that our R&D staff can respond to?

Q: Are companies trying to innovate without business models?

A: No. My observation is that when a company has a very successful business model, it tends to filter everything subsequent through the lens of what worked in that business model. For example, Xerox did a great a job of developing things that turned into high-speed copiers and high-speed printers. These things started out as mechanical devices, and they became electro-mechanical, and finally they became electronic and fully digital systems. So Xerox navigated a very significant series of technology transitions in its core business. That it managed very, very well. Where I think the company fell down was that it couldn't think of alternative ways to use those technologies that didn't help it make high-speed copies and printers, to create value for its shareholders.

Q: You show that more than 20 companies were spun off from Xerox Palo Alto Research Center. At the time, this was seen as a tragedy for the company. How does it look today?

A: My take on that is different from the conventional wisdom, which is that the idiots in corporate didn't get it, and this stuff just leaked out, and they fumbled away their future. But my research shows that most of the companies that came out of PARC--and actually out of all the Xerox laboratories--had a license from the company to leave, and the company was actually trying to exit these research initiatives so it could put its research dollars toward other priorities it thought would be more helpful to its business. So again, it was doing a good job of trying to screen things for its copier and printer businesses, and it was actually managing pretty well according to those objectives. The problem wasn't that it didn't have objectives. The problem was new businesses and new growth outside its current business. The companies that left PARC had a problem: They had a technology, and now they had to go find a business model to make use of it.

There are examples of companies that didn't evolve a different business model, and they actually failed. Of course, a lot of spin-offs do fail. But the ones that succeeded did so in large part because they took the technology to market in a very different way through a very different business model, typically involving a lot of external parties and complementary producers. Also, they didn't try to do the whole value chain themselves; they actually partnered with other companies to do a piece of it. That was something that didn't come naturally to Xerox. Even today, everything Xerox does and sells, it pretty much does on its own.

Q: Innovation relies on information. Yet you state in your book that many companies fail to take full advantage of the wealth of information available to them. Where's the disconnect?

A: We live in a complex world, and there's a lot of information flying around all the time. Having been a manager myself, I remember vividly how crazy and confusing it can be. You can't possibly process each and every new piece of information that comes along. You filter the stuff that you think isn't important, doesn't connect to what you already do, and that you already know. You try to screen for the stuff that will help you move forward. As human beings, we have to process information that way; it's part of our cognitive process.

I argue that companies have cognitive processes and preferences, too. So these business models aren't just ways of turning technology into money. They're also filtering devices for what information companies react to and what information they process, versus the stuff they leave out.

Q: Another important aspect of innovation is intellectual property. You seem to think companies aren't doing an especially good job of managing or taking full advantage of IP beyond using it in their own business. Why? And what might they be doing instead?

A: There are companies that I think are doing a good job of it, but there are also a lot of companies that don't. One problem is that companies delegate IP to the legal staff. While the lawyers are excellent technically in the legalities of intellectual property, they're not strong in the management of IP. We've been talking about the not-invented-here problem and how engineers and scientists tend to devalue external technology relative to their own, internal technology. Well, that's a big problem when you're thinking about trying to bring in outside ideas. Because how do you evaluate the quality of an external idea or technology? You typically use your R&D staff to help assess the quality of what's there. The legal staff isn't in a position to second-guess the technical judgments on the merits of the technology, so they typically have to defer to the engineers and scientists. As a result, there's probably a lot less technology brought in than maybe there could or should be.

How do you manage or overcome that? Well, you need a leadership role that involves the legal staff, so they're part of the process, but also involves the R&D staff and has an overall corporate perspective on what the company is trying to do. The way you should think about it is, anything that fits your business model, whether it comes from inside or outside, is valuable. So you should be looking actively for stuff both inside and outside that fits your business model. Then you have to overcome the not-invented-here problems to get that stuff successfully put into your company.

Proctor & Gamble's corporate objective to have half its ideas in five years come from outside is a stretch objective to lead the organization to shift the way it does business. That's another thing you could never delegate to your legal staff. They can't make those commitments on their own; it has to come from the top management of the company.

Q: Let's talk about the dramatic changes at IBM. You dedicate a whole chapter in your book to IBM. What's the main lesson here?

A: I joined the industry in '83, and in those days we talked about Big Blue. I used to say that if you wanted to buy a disk drive from IBM, you had to buy it inside an IBM computer! You had to buy the computer from an IBM salesperson, and you had to have it sold, serviced, and supported by IBM staff. A lot of people would say IBM was more like a country than a company. It was an enormously successful company, but also a deeply vertically integrated, inwardly focused company. IBM is still a very large company, and it hasn't eliminated bureaucracy from its organization. But strategically, what I give it a tremendous amount of credit for is that it has shifted its business model from having to do it all itself to making money by integrating what it does with what other people do and delivering solutions to customers.

I heard recently from IBM that it's the largest reseller of Sun Microsystems equipment-not because it inherently loves Sun; they're pretty aggressive competitors. But IBM is in the business of solving customers' problems, and a lot of the time, that involves Sun equipment. I'm sure IBM would love to switch customers to IBM gear, but its business model allows it to sell Sun equipment, bundle it with a bunch of other stuff (some of which will be from IBM), and it makes money doing it.

Q: I think of IBM's success with Linux as another great example.

A: Yes, Java and Linux are two other examples. This is the company that invented Cobol and Fortran, and it has a proud history of computer languages. Yet here are two languages--Java and Linux--that it didn't discover, didn't develop, and doesn't own. Yet my understanding is that IBM is the largest single supporter of both of those languages. That is, there are more people at IBM working in those languages than at any other single company. Now, obviously, some of that is to tweak Microsoft's noise, and it hasn't escaped IBM's attention that it's in IBM's interest to have a viable competitor to Microsoft. But you still have to give IBM credit: This is a company that's committing a lot of resources to stuff it doesn't fully own itself.

Q: What are the steps a company should take to make the transition from a closed-innovation company to an open-innovation one?

A: First, how can you get more awareness of other stuff you could draw on? One way is to find a local university, and offer to give a talk, take a faculty member out to lunch, maybe sponsor a graduate student for a summer at your company. These don't cost a lot of money; they just take time and effort. But they help open the connections to what's going on in that engineering school, for example. It could be a business or medical school, too, depending on your business.

Another idea is to get to know the venture capitalists who are active in your industry. Chances are, those folks see opportunities that many of the established companies are missing. Rather than just assuming they have it all wrong, take the time to listen to what they have to say. The good news is that VCs these days are eager to understand the needs of larger corporations. A few years ago, they thought the big companies were all dinosaurs, and they were going fund the new generation. But today they realize that companies have to learn how to work with big companies if they're going to have a chance of becoming a big company themselves.

On the outbound side, there's Procter & Gamble's idea of use it or lose it. Be willing to go through your own patents and say, "Well, why aren't we trying to do something with these patents?" Maybe license them or work with other companies that might be interested in them. Try to get additional monies out of the intellectual property that your company holds.