Presentation for the book "Open" by Haas Professor H. Chesbrough

1. Business Model Innovation:
The Next Frontier in Innovation
Presentation on the Occasion of
the Launch of “Open Business Models”
Firenze, Italia
Henry Chesbrough
Haas School of Business
UC Berkeley
© 2008 Henry Chesbrough 1

2. The Current Paradigm:
A Closed Innovation System
Science
& The
Technology Market
Base
Research Development New Products
Investigations & Services
R D&E
© 2008 Henry Chesbrough 2

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 3

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 4

5. The Open Innovation Paradigm
Other Firm’s
Licensing Market
Technology Spin-offs New
Internal
Market
Technology
Base
Current
External Market
Technology
Base
Technology Insourcing
© 2008 Henry Chesbrough R D 5

6. Closed innovation
Open
Other firm´s
market
Licence, spin Our new
out, divest market
Internal
technology base
Internal/external Our current
venture handling market
External technology
insourcing
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
6 C 2002 Henry Chesbrough EIRMA SIG III, 2005-10-20

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 7

8. What is Innovation?
Before
• Invention
• Product
• Technology-driven
• Internally generated
• Engineering’s job
© 2008 Henry Chesbrough 8

9. What is Innovation?
Before After
• Invention • Commercialization
• Product • Business, including
process and biz model
• Technology-driven • Business/value-driven
• Internally generated • Internal Integration of
• Engineering’s job int. and ext. stuff
• Everyone’s job
© 2008 Henry Chesbrough 9

10. What is a Business Model?
• Creates Value
• Captures a portion of that value
© 2008 Henry Chesbrough 10

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 11

12. Which Would You Rather Have?
• A Better Technology
Or,
• A Better Business Model
© 2008 Henry Chesbrough 12

13. Graphic Illustration of a Generic
Airline Business Model
Passengers Revenue
Air Travel
Costs
Food
Airport Aircraft, Fuel Cleaning
Runway Checkin Jetway
© 2008 Henry Chesbrough 13

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 14

15. The Ryan Air Business Model
Passengers Air Travel
Revenue
Food
Airport
Aircraft, Fuel
Car Hire
Hotels
Shopping
& Food Parking
X
Jetway
X
Checkin X
Cleaning
© 2008 Henry Chesbrough 15

16. IBM: Its Closed Value Chain
All IBM – pre 1993
Solutions
Value-Added Activities
Applications
Productivity SW
Operating Systems
Computers
Chips, devices
Atoms Materials
Value Chain
© 2008 Henry Chesbrough 16

17. IBM’s Open Business Model
Integration Other Integrators
Solutions
Value-Added Activities
Applications Applications
Productivity SW Productivity SW
Operating Systems Operating Systems
Computers Computers
Chips, devices Chips, devices
Atoms Materials Materials
IBM Chain OEM Market
© 2008 Henry Chesbrough 17

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”
© 2008 Henry Chesbrough 18

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 19

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 20

21. Stage 1-Undifferentiated
• Commodity
• No differentiation
• Hard work, hustle, luck
• Can’t attract capital, can’t scale
• Example: most restaurants
© 2007 Henry Chesbrough 21

22. Stage 2-Differentiated
• Performance advantage
• Ad hoc processes
• Hard to sustain
• “one hit wonders”
• Example: most technology startups
© 2007 Henry Chesbrough 22

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 23

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 24

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 25

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
© 2007 Henry Chesbrough 26

27. Who Owns Business Model Innovation?
Marketing?
Research and Development?
Operations? Business
CEO/COO
Unit GM
?
Corporate Strategy Office? ?
Business Development?
Finance?
| 27
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28. Why Business Models are Hard to
Innovate: Mapping Across Domains
Business
Technical Model Economic
Inputs: • target market Outputs:
e.g., • value prop. e.g.,
feasibility, • key attributes value,
performance • value chain price,
• how paid profit
•Value network
Measured in technical domain Measured in social domain
© 2007 Henry Chesbrough 28

29. Type I and Type II: Xerox and PARC
Designed to minimize “false positive” errors
© 2007 Henry Chesbrough
Ignores risk of “false negative” errors 29

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 30

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 31

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 32

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 33

34. Different Financial Processes
Chess: Type I errors Poker: Type II errors
• Plan several moves • Pay to play
ahead
• Pay for new
• No new information
information needed
• You know what • You discover what
you’ve got, what you’ve got, what
opponent has other players have
• NPV • Options
© 2007 Henry Chesbrough 34

35. Xerox: Great at Chess, Lousy at Poker
40000
Xerox 3Com
35000 Adobe Doc Sci
Documentum FileNet
30000 Komag Objectshare
SynOptics SDLI
US Dollars (millions)
25000 VLSI Sum (10)
20000
15000
10000
5000
0
78
80
82
84
86
88
90
92
94
96
98
00
19
19
19
19
19
19
19
19
19
19
19
20
© 2007 Henry Chesbrough 35
Year

36. The Economic Pressures on Innovation
Revenue
Market
Own
Revenues
0
Internal.
Development.
Costs
Costs
Closed
Model
Before
© 2007 Henry Chesbrough 36

37. The Economic Pressures on Innovation
in the Market
Product Life
Shorter
Revenue
Market
Own
Revenues
Own
Market
Revenue
0
Internal. Internal
Development. Development
Costs
Costs Costs
Rising costs of innovation
Closed Closed Model
Model After
Before
© 2007 Henry Chesbrough 37

38. The New Business Model of Open Innovation
Revenues
New Mkts
New
Spin-off
Revenue
Licensing
Own Own
Market Market
Revenue Revenue
Internal. Internal and
Development.
Cost
External Dev.
Costs Costs
Cost and Time savings from
leveraging External development
Closed Open Innovation
Model Business Model
© 2008 Henry Chesbrough 38

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