Implementation Issues With any partnership, there are sure to be implementation issues, if not problems. Consider the case of Clorox and its Green W

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Strategic Outsourcing: An International Journal Vol. 1 No. 2, 2008 pp. 100-121 # Emerald Group Publishing Limited 1753-8297 DOI 10.1108/17538290810897138

Building strategic partnerships for managing innovation

outsourcing Peter Baloh

Faculty of Economics, University of Ljubljana, Ljubljana, Slovenia

Sanjeev Jha University of Illinois at Chicago, Chicago, Illinois, USA, and

Yukika Awazu Bentley College, Waltham, Massachusetts, USA

Abstract

Purpose – The purpose of this paper is to uncover the mechanisms of organizations managing innovation outsourcing to business partners. In a business environment characterized by the development of deep, niche expertise in a particular domain, business partnerships can provide a source of innovative rejuvenation by outsourcing the innovation to business partners who have complementary skills and expertise. This paper addresses a critical challenge which the organizations are currently facing: how do you manage outsourcing of innovation to business partners effectively while maintaining your strategic competitiveness? Design/methodology/approach – Exploratory multiple case studies of over 30 innovative European and US companies were done. It involved 50 semi-structured interviews with senior executives from research and development, product management, information technology, and marketing. Findings – The paper identifies three complementary models of managing outsourcing of innovation to business partner: acquisition, strategic alliances, and open source (OS). Based on these, a three-dimensional ‘‘Co-Innovation Space’’ is proposed that can help in analysis and planning of current and future innovation projects. Research limitations/implications – Although the research is carefully designed, it is an exploratory study and has the limitation of generalizability of the findings. Nevertheless, findings from multiple case studies from diverse organizations shed a light to current innovation and strategic alliance literature. Practical implications – Partnerships can open the door to multiple knowledge sources. Accessing and integrating information from these sources can greatly enhance knowledge base of organizations and can help fuel sustainable innovation. The models proposed in this study provide a lens to examine existing innovation project portfolios and/or to plan for future innovation programmes. Originality/value – This study is probably among few to study such a large, diversified, and geographically scattered group of organizations. Although exploratory and preliminary, this makes the findings of the study insightful.

Keywords Innovation, Strategic alliances, Acquisitions and mergers, Partnership, Outsourcing

Paper type Conceptual paper

Introduction Worldwide, executives agree that collaborative innovation is indispensable. When asked about the most important sources of ideas and innovation, CEOs ranked employees first (41 per cent of CEOs agree that they are the number one source), closely followed by external sources such as business partners and customers (39 and 36 per cent, respectively (IBM, 2006)). Internal research and development (R&D) departments, in contrast, ranked only eighth in importance (IBM, 2006). The nature of innovation has undergone fundamental changes in recent times (Chesbrough, 2003).

The current issue and full text archive of this journal is available at www.emeraldinsight.com/1753-8297.htm

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Today, it is not sufficient for an organization to simply rely on its internal knowledge base for ideas (Carayannis, 1999; Chesbrough, 2003; Desouza et al., 2005; Dodgson, 1991; Hitt et al., 2000). Organizations have realized that they must partner with external entities to source ideas, know-how, and capabilities.

Organizations have become highly specialized in niche areas, often focusing their capabilities on specific expertise, services, or products. Organizations must hone in on their core capabilities and engage with business partners to supplement, expand, and apply knowledge. In this way, they can balance their deep expertise with partner’s expertise in order to innovate efficiently and effectively; and this is what good companies should do (Sull, 1999). While developing existing technology and serving existing customers results in incremental innovations, exploration into new knowledge or departure from existing skills leads to radical innovation serving emergent customers or markets (March, 1991; Benner and Tushman, 2003; Herrmann et al., 2006). Complementary assets help an organization extend the reach, scope, and impact of their products and services to reach market faster with better and new products. This realization has fuelled the recent surge of interest in outsourcing, both on- and off- shore. Organizations engage in partnerships to reduce the costs of internal knowledge creation. Moreover, when the need for knowledge in allied or foreign domains arises, many organizations lack the capability or capacity to grow the knowledge in-house – they need to negotiate for the ideas and know-how from external sources. Quinn (2000) cites the example of large pharmaceutical companies outsourcing elements in their innovation chain while specializing in their core activities. Breaking core competencies into three broad areas of basic research, development, testing and production, and distribution, the author argues that companies specialize in each of these three areas while collaborating with other. Companies specializing in R&D build partnership with firms having core competencies specializing in the other two elements in the innovation chain: production (testing and production) and marketing, distribution, and logistics (distribution).

Miozzo and Grimshaw (2005) argue that vertical disintegration and modularity of innovation chain is one of the most significant phenomenons of modern organizations. Organizations can generate faster and better products by breaking them into smaller subsystems that can be built separately but to function together. However, to achieve this, organizations need to have a sound strategy to manage the outsourcing of their subsystems. We have examples of a number of organizations practicing outsourcing of subsystems requiring their suppliers of components and services to conduct their own innovations, while they focus on innovations in their core competency. Boeing actively solicited business partners in the innovation process for its new 787 Jetliner (Kotha and Nolan, 2005). Boeing created a team of 15 companies worldwide for production of the structural sections of the plane. For example, Mitsubishi Heavy Industries (Japan) is responsible for the wing box. Vogut and Alexia (Italy) are building the horizontal stabilizer and the centre and aft fuselage. Product suppliers are not the only business partners, either. Services can be outsourced, too. Most organizations today outsource some aspect of their human resource functions (e.g. executive recruitment). In doing so, they rely on the expertise of their providers to bring them the best-of-breed in both product and service offerings.

The shift in the mindset towards outsourcing of innovation is driven by increased competitive pressures. Globalization makes the need for innovating with business partners more critical. In this age of rapid innovation, organizations cannot stay at a static level of skills and competencies. Organizations need to ceaselessly create

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knowledge, innovate processes, and products, and learn from their predecessors’’ mistakes and services. Organizational improvisation (Cunha et al., 1999) is the mantra to break out of this loop of the birth and death of organizations. The loop has always been there, but globalization shortens the process. Organizations need to improvise, experiment, and employ all their resources, especially their employees, business partners, and customers, in a continual quest for organizational improvisation. This demand and complexity helps to explain why opening an innovation process by outsourcing external parties may be a challenging undertaking.

Further, innovating in isolation can be risky and costly. Out of ten R&D projects, five flop, three are abandoned, and two go on to become successful (Rizova, 2006). A large number of innovative ideas fail due to the lack of market orientation, such as with misengineered products that do not fit customer needs. Consider the example of high- definition television, a technology marvel that promised high picture quality. Philips, Sony, and Thompson have invested millions and millions of dollars to produce consoles since the early 1990s, but they were not in-sync with their business partners; the product languished because the studio production equipment, signal compression technologies, and broadcasting standards were not ready (Rizova, 2006). To maximize profit potential, a company needs to identify its innovation fulcrum, the point at which an additional offering destroys more value than it creates (Gottfredson and Aspinall, 2005).

If done properly, outsourcing to business partners can help organizations to achieve sustained innovation and continuous competitive differentiation. Toyota is an excellent example. Despite the amount of research conducted on the Toyota Production System and the fact that Toyota even provides tours of its operations to other companies’ representatives, competitors have not been able to achieve the same level of productivity as Toyota (Hagel and Brown, 2005). One important reason is that knowledge resides and is owned at the network level. Participating suppliers benefit from knowledge sharing as they themselves gain from others’ knowledge (Dyer and Nobeoka, 2000).

In this paper, we describe three mechanisms by which organizations engage with their business partners for outsourcing of innovation. These three modes of collaboration are differentiated by the nature of relationships among partners, reasons (goals) behind the decision for particular relationships, and by the scope of innovation. In each business partnership, it is critical to identify what type of innovation is most likely to result in successful outcomes. There is no one-size-fits-all approach. Henderson and Clark (1990) classified innovations in two dimensions: one dimension captures an innovation’s impact on components and the other on the linkages between components. Through this classification, they identified multiple types of innovation: incremental, modular, architectural, and radical innovation. Architectural innovation illustrates how some business partnerships can lead to desired innovation effort outcome. Henderson and Clark posit that architectural innovation is triggered by a change in a component, which will create new interactions and new linkages in the established product. Business partnerships often create this catalytic effect by combining or incorporating complementary and necessary components in each participant’s product and services. This type of innovation is very complex and risky, and most often requires a variety of knowledge and expertise that are not located internally in the firm. It can also be highly disruptive to organizations (Gatignon et al., 2003). This paper focuses on such complex and disruptive innovation. We discuss under what conditions each mechanism of outsourcing is beneficial, and the risks and

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issues related with each mode of collaboration. We also explore the critical issues related to actually introducing new forms of collaboration in organizations. Understanding these issues can help organizations better manage the demanding and multifaceted task of fusing business partners into already complex innovation processes. Finally, we introduce a three-dimensional ‘‘Co-Innovation Space’’, which is akin to various matrices (such as Boston Consulting Group (BCG), Arthur D Little (ADL), GE/McKinsey, etc.), known from the strategic management. Companies can use it to analyze existing innovation portfolios and/or to plan future approaches to innovation outsourcing.

The findings presented here are based on exploratory multiple case studies of over 30 innovative European and US companies. This research design was chosen as it suits problems where the context of action is critical (Benbasat et al., 1987), as it enabled us to gain a rich understanding of the context of the research (Saunders et al., 2003), and as it made possible describing in greater detail the relationships that exist in reality in local contexts (Galliers, 1992). Data collection involved 50 semi-structured interviews with senior representatives from R&D, product management, information technology, and marketing. The interview data were complemented by desk research, analysis of corporate reports, and validated in follow-up sessions with key informants.

Building strategic partnerships for innovation outsourcing During our exploratory study, three different forms of business partner collaboration for innovation outsourcing emerged. In this section, they are defined and managerial issues are discussed. The first collaborative mode is innovation through acquisition, where ideas and innovations are acquired from another independent organization in exchange for (usually monetary) compensation (Karim and Mitchell, 2004; Lichtenthaler, 2005). The next type of collaboration is strategic alliances, where numerous business partners engage in a highly dynamic interplay of tapping into external sources of knowledge, assimilating new knowledge, and transforming and exploiting the knowledge (Doz and Hamel, 1997; Hipkin and Naude, 2006). Finally, the OS innovation model, which is where problems and ideas are exchanged via the network to enable more rapid innovation and access to a wide array of sources of expertise (Grand et al., 2004).

Outsourcing of innovation through external knowledge acquisition Consider IBM, which realized US $1,700 million (20 per cent of their total net income) in 2000 via external commercialization of their expertise. This took the form of consulting and services related to many of their 25,000 patents (IBM, 2005; Kline, 2003; Lichtenthaler, 2005). The number of transactions involving the trading of knowledge assets has increased significantly from US$ 15,000 million per year at the beginning of the 1990s to around US$ 100,000 million a year in 2002 (Kline, 2003). If the supply side is thriving, demand must be high. Many organizations engage in outsourcing of innovation by purchasing knowledge from external entities.

Outsourcing of innovation through external acquisition has several benefits. First, an organization can choose to purchase the best-of-breed and incur neither the cost nor the risk of in-house innovation. Furthermore, in an era of specialized business, many organizations focus upon specific areas of expertise, and their employees may not have the diversity and breadth of knowledge to develop technological or product innovations outside the business’s dominant field or business model.

Second, the purchasing organization can act in an agile manner and acquire knowledge that arises out of emergent needs. When a need is recognized, a company

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can search for and buy the knowledge that will answer that need immediately. That might take the form of new technology, manufacturing procedures, or a product component. In these instances, an organization sidesteps the costly and sometimes lengthy R&D cycle and is able to seize solutions found to match core competencies and supplement organizational strengths. As the competitive environment is highly dynamic, being able to satisfy emergent needs is critical.

Third, sometimes intellectual property safeguards particular pieces of knowledge. In these instances, an organization may work with a business partner who has the rights to a particular patent in order to use a specific product component or piece of technology. The patent holder may retain the right to commercialize its knowledge with other organizations; at other times, the patent itself will be for sale and can be acquired entirely. Sometimes, a business partnership develops out of necessity to access or utilize information held explicitly and legally by a partner. Consider the example of Zebra Technologies. This leading manufacturer of industrial printing solutions (such as bar code and radio-frequency identification (RFID) smart labelling) has acquired an extensive portfolio of RFID-related patents in 2006. With a US$ 10 million acquisition of over 200 patents from UK-based medical company BTG plc, Zebra now holds a vast collection of patents that secure their premium position in the lucrative and promising area of products based around RFID technology. These patents are integrated in their products, which are used by 90 per cent of the Fortune 500 companies. In addition, Zebra’s knowledge and expertise also is a viable consulting industry with companies’ partners who try to stay in the supply chain. As an example, in April 2006, Zebra held a conference for over 300 suppliers of Wal-Mart, who were facing the giant retailer’s RFID compliance mandate.

The case of the ‘‘Little Swan’’ company (Pech et al., 2005) demonstrates that innovation can be successfully integrated into a firm after direct acquisition. Acquisition of foreign technology propelled the company from being a pottery and domestic appliances producer with no history of technological development to a company with an 18 per cent yearly expansion rate in the highly competitive and low- profit-rate world market of white-ware manufacturing. Little Swan had the reputation of being a ‘‘me-too’’ copycat rather than an innovator. In 1989, Little Swan was in 24th place in washing machine sales in China and made a commitment to internal R&D around that market. The transfer of critical technology and hiring of engineers from the Japanese manufacturer Matsushita in 1987 acted as a catalyst, enabling Little Swan to design proprietary technology of its own. The purchased expertise was paired with incremental innovations from in-house R&D, which resulted in over 150 patents by the year 2002, both in innovative products and in innovative manufacturing procedures. Huge incentive programmes have been employed, and the company continuously expands its knowledge base with experts from all over the world who can fruitfully engage in new knowledge creation around diverse knowledge bases (Pech et al., 2005).

The case of South Korean electronics giant Samsung provides another an analogous example. In the late 1990s, Samsung was associated with cheap TVs and microwaves that flooded foreign markets. During the Asian economic crisis, Samsung undertook an innovation transformation, starting first with improving acquired patents. While those purchases improved products dramatically, they did not merely release as new products. Instead, the acquisitions were paired with radical strategy shifts in managerial training, strong leadership, and a huge R&D emphasis under the watchword of quality. Today, Samsung is the third-ranked mobile phone producer in the world; it was rated the ‘‘Mercedes’’ of cell phones (Manecksha, 2004) and has been

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called ‘‘a killer innovator’’ (Ihlwan, 2006). For example, Samsung was the first to introduce an MP3 player to the global market (two years before the iPod) and to integrate MP3 players into mobile phones. It is the number two chip-maker in the world after Intel and the top maker of LCD driver chips, with around 20 per cent of the market; among its customers are Sony, Nokia, and Motorola.

The examples of Samsung and Little Swan emphasize that outsourcing of innovation through acquisitions alone do not lead to sustainable innovation. In each of these instances, key patents were acquired and then merged with new, high-quality employees and a cultural shift towards valuing quality and innovation. The combination of new knowledge and a cultural shift enabled both companies to develop innovative products; the patents alone probably would not have had such a significant, long-term impact. The process of integrating external knowledge opened the organization up to new knowledge while simultaneously providing initial successes in product development that further fuelled the process of change. This virtuous cycle allowed Samsung and Little Swan to continually ramp up their innovation programmes after each successful release of a product.

Critical considerations. Not all innovations are candidates for outsourcing through external acquisitions. After both our literature review and our case studies, we put forth the following hypotheses for future research. First, external acquisitions are mainly suitable for products and services that have a rich history and a mature track record. This is because such products and services are well understood, making it easy to estimate their value and calculate their price. The prime example of this is in the area of information technologies. Today, most organizations purchase their IT services, solutions, and components from technology providers. Innovation in IT is not conducted in-house. Rather, organizations have come to expect that the business partners from whom they purchase these goods take responsibility for innovation.

Second, outsourcing through external acquisitions is ideal when the purchased knowledge or ideas can be easily integrated into the current organizational fabric. By this, we mean that the effort required to integrate innovations into the organization should not be inordinately high enough to make it useless to purchase them off-the- shelf. If there is need for special expertise to help the organization integrate these innovations, the costs of the additional expertise need to be accounted for as part of the overall project.

Third, outsourcing through external acquisitions should be used for purchasing innovations in non-core areas of the organization. Non-core innovations, compared with core innovations, are not critical to the operations of the business. Core innovations can make or break a business; hence, when engaging with business partners on core innovations it is better to use the second mechanism that we discuss, innovation through strategic alliances.

Fourth, if a company feels that there is outstanding potential in particular knowledge that can be bought, sometimes it engages in outsourcing knowledge acquisition through transfer of patents from the commercializing to acquiring company.

Outsourcing of innovation through strategic alliances One of the main motivations for the creation of innovation-focused alliances is to source new knowledge and learning. When two organizations are already competitively strong, one or both parties may want to acquire critical knowledge, while maintaining their own capabilities (Doz and Hamel, 1997; Kogut and Zander, 1992;

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Wonglimpiyarat, 2004). Alliances enable a company to intercept the technology of another company and to close skill gaps faster than internal development would allow (Doz and Hamel, 1997). Alliances also foster intense interaction and that collaboration enables the transfer of tacit knowledge between members.

Strategic partners need to be sought out and a collaboration structure needs to be formed. Relationships then need to be built and managed throughout the project (Hipkin and Naude, 2006; Marshall, 2004). Doz and Hamel (1997) suggest that an important antecedent for successful innovation alliances is the strategic, organizational, and cultural compatibility of the partners. The selection and engagement of complementary alliance members is critical for successful outsourcing during innovation processes (Yoshingo and Rangan, 1995). The search for potential partners must be systematic and consider contextual factors like competition, market situation, and existing knowledge base. To facilitate the search, even web-based evaluation tools have been devised (Humphreys et al., 2005). Strategic and cultural issues come into play because the search for partners must also consider the roles that the integrating company wants the partner to play in the alliance.

To find the appropriate partners for innovative alliances, several factors should be considered. Achieving a strategic fit between the allies is vital (Rotering, 1990; Teichert, 1994; Drejer, 2002; Lindman, 2002). Strategic fit (e.g. Rotering, 1990; Teichert, 1994) is related to the danger of opportunistic behaviour from one partner and therefore inversely depends on the advantages both parties could gain out of the integration (Dutta and Weiss, 1997). Appropriate partners need to be chosen considering the goals set by the integrating company for a strategic alliance. In our study, interviewees repeatedly stated that the complementary knowledge base of the business partner(s) is the key selection factor. Trust and reliability is also important in selecting innovation partners and is just as important as the complementary competences of both parties. Unlike with external acquisitions, in strategic alliances both partners must have knowledge to share and contribute and the benefits for both organizations must be articulated and continually reinforced. Cultural fit is another critical consideration. Cultural fit increases when decision processes and decision speed, tolerated risks, and work-related values are similar. Also, the willingness to adapt to cultural differences, which can arise both at an organizational and global level, improves the cultural fit.

Successful innovative alliances consider not only factors concerning the organizations involved, but also the type of project being embarked upon. The results of our study show that companies that are successful at integrating external knowledge begin by considering the strategy for integration. They outline the goals of the integration, roles for each company involved, and areas of integration. Our findings principally support the findings of Wagner and Hoegl (2006), who studied the integration of suppliers in the new product development process, and extend the data to include technological (process) innovation. Companies distinguish between two types of integration strategies – know-how and capacity projects.

In know-how projects, a firm’s intention is to utilize the specialized knowledge of a business partner. For goal-oriented new product projects, which are highly innovative, the integrating company takes on suppliers with deep knowledge in a particular area and transfers the responsibility directly to the supplier (Wagner and Hoegl, 2006). When embarking on strategic innovation alliances, it seems from the companies we analyzed that such joint ventures have characteristics of the know-how projects. They arise out of the need to adopt complementary knowledge when developing in-house

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technological knowledge. Furthermore, not only the ‘‘end product’’, but also the ‘‘means to that end product’’, is critical.

In that sense, we saw less transfer of responsibility to the strategic alliance partner but more joint collaborative efforts in developing new ways of doing things. A recent example is Samsung’s partnership with Mechanical Technology Inc. (MTI) Micro Fuel Cells of Albany, NY (MTI), a unit of Mechanical Technology, a little-known company that had $8 million in sales in 2005. MTI Micro has extensive technological knowledge in the area of ‘‘green’’, micro-sized electricity sources. Samsung committed $1 million to the joint development of fuel cells, one of the largest publicly disclosed commitments to the technology by a major manufacturer in years. Goals, knowledge security, and the question of intellectual property were explicitly defined in advance. The joint development deal will last about 18 months, and neither company will work with any other companies to develop fuel cells for use in wireless phones. Samsung secured an exclusive license to use the technology from MTI Micro, and any patents that result from the research will be assigned to MTI Micro.

Critical considerations. From the literature, we know that opportunities for knowledge base expansion exist mainly in combining knowledge across new domains; this recombination view of existing physical and conceptual resources has long been accepted as a strong source of possible innovation (Schumpeter, 1934). However, while outsourcing external knowledge from distant domains may be novel and valuable, firms may have difficulties in absorbing and utilizing this knowledge. In line with this, Hipkin and Naude (2006) agree that alliances will benefit mostly from multiple capabilities, which may lead to haphazard, nonlinear outcomes. Specializing too much in a particular domain, however, can lock a firm into a competency tr

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