Earlier this year, UC Berkeley professor Henry Chesbrough published a new book, Open Services Innovation: Rethinking Your Business to Grow and Compete in a New Era. This is his third book on open innovation in the last eight years, having published Open Innovation: The New Imperative for Creating and Profiting from Technology in 2003, and Open Business Models: How to Thrive in the New Innovation Landscape in 2006.
Professor Chesbrough is in the faculty of Berkeley’s Hass Business School and executive director of the Garwood Center for Corporate Innovation and of the Program in Open Innovation. I met him over a decade ago when I first got involved with Linux and open, collaborative innovation. He is a top expert on the value of open innovation to business.
When I recently found out that he had published a book on services, I was eager to learn how he framed the subject. For over ten years now, I have been thinking about the application of technology and innovation to services. Over the years, I have given quite a few seminars on the subject, including a graduate course in MIT in the Fall of 2010. I have also written a number of entries on services in this blog.
“[S]ervices have been the growth vehicle in advanced economies for some time,” writes Chesbrough in the book’s opening chapter. “In the United States, they have risen from a very small percentage of the economy a century ago to more than 80 percent of gross domestic product today. Services comprise more than 60 percent of the gross domestic product of thirty-ﬁve of the top forty economies in the OECD. Growth will come from services in the future for these economies.”
His key argument for the importance of services innovation is the serious competitive challenge faced by many product companies, which he calls the commodity trap. The commodity trap is the result of three key business forces:
“Manufacturing and business process knowledge and insights are widely distributed. It is getting harder for companies to differentiate their products and sustain that differentiation over time.”
“Manufacturing of products is moving to areas of the world with very low costs. Computers and networks are spreading product designs and process tools around the world, where products can be produced cheaply.”
“As challenging as the spread of best practices around the world is to product manufacturers, another force compounds their predicament: the shrinking amount of time a product lasts in the market before a new and improved one takes its place. As a result, even successful products can expect to enjoy an advantage in the market for a shorter time than in the past.”
The commodity trap applies not just to the development and manufacturing of physical products. It also applies to standardized, routine service offerings. These offerings have either been fully automated using IT systems, - e.g., ATMs and other financial networks, or access to information over the Web, - or have moved to areas of the world with lower labor costs. Such routine service offerings are essentially products, so much of what Professor Chesbrough says about physical products applies to them as well. Given the continuing advances in digital technologies and networks, we can expect the commodity trap to become an even greater competitive challenge in the future.
What should companies do? “In order to grow again and compete effectively, businesses must change the way they approach innovation and growth. They ﬁrst have to confront, and then transcend, the commodity trap. They have to stop thinking like product manufacturers and start thinking about business from a services perspective. Both companies that make products and those that deliver services must think about their business from an open services perspective to discover new ways to generate proﬁtable growth.”
Chesbrough’s framing of services innovation is similar to the approach followed in one of my favorite books on the subject, Services is Front Stage: We are all in Services . . . More or Less!, by James Teboul, Emeritus Professor at INSEAD.
Professor Teboul offers a simple and powerful definition of services. Every organization, whether in business, government, health care or education consists of front stage and back stage activities. Services deal with the front stage interactions; manufacturing and production with the back stage operations. People are prominent in front stage activities, providing solutions to problems and focusing on achieving a positive customer experience in a collaboration between the providers and consumers of services. Product excellence and competitive costs are key to back stage activities, which tend to focus on specialization, standardization and automation.
Given this definition, every business and institution is involved in services to a greater or lesser extent, because its activities will involve front stage interactions as well as back stage operations.
Professor Teboul observes, “We are all in services now, more or less, but we will be even more in services in the future, as the back end shrinks with economies of scale and outsourcing and the front end develops further with more sophisticated demands from customers. What is important is to weigh the relative importance of the back stage and the front stage and to understand how to manage those two very different worlds that are often in conflict but need to be aligned and coordinated.”
This is a very good operational and practical definition of services, very much in line with the framework in Open Services Innovation. Chesbrough's framework is built around four key concepts:
Concept 1. “Think of your business (whether a product or a service) as an open services business in order to create and sustain differentiation in a commodity trap world . . . Creating a complete experience for your customers or an experience that is as complete as one you are able to envision offering.”
He recommends that companies split their organizations into customer-facing front-end units, whose job is to deliver customized solutions to clients; and back end functions built on standardized processes, which can be easily reconfigured to support the customized requirements of individual clients.
Concept 2. “Invite customers to co-create innovation with you in order to generate the experiences they will value and reward . . . Instead of treating customers as passive consumers, many companies are now involving customers in the innovation process. In many cases, customers are actually co-creating new products and services.”
Unlike standard products and services, it is much harder to write precise specifications for customized client solutions, because much of the knowledge involved is tacit in nature, gained from experience and much harder to write down. Complex projects based on tacit knowledge require very close collaborations between suppliers and customers.
Concept 3. “Use Open Innovation to accelerate and deepen services innovation making innovation less costly, less risky, and faster. Use Open Innovation to help you turn your business into a platform for others to build on.”
Having seen the success of the Internet and World Wide Web, Linux, Wikipedia and a number of other community-based offerings, the value of open, collaborative innovation is now much better understood and accepted in business. While challenging because of the required cultural changes, open collaborative innovation is increasingly viewed as a critical business process that companies need to embrace in order to better keep up with the accelerating changes in technologies and markets.
Concept 4. “Transform your business model with Open Services Innovation, which will help you proﬁt from your innovation activities. If you succeed in building a platform business model, you can also proﬁt from others’ innovation activities as well.”
Arguably, the biggest business benefit of customer-facing services innovation lies in the new business models that are now possible. Product-based business models are transactional in nature. Services-based business models are built around long term customer relationships and recurring revenues. Such business models are the answer to the product-based commodity trap that afflicts so many companies.
Let me conclude with Professor Chesbrough’s summary of the value of Open Services Innovation to business:
“More and more companies are discovering that by focusing on service offerings, they can get a better sense of the utility customers want from a product. This is a key point for two reasons: First, it helps companies provide real value to customers - which may prevent them from switching to lower-cost competitors - and second, the knowledge gained about a customer’s challenges will provide insight that an organization’s competitors may not even know. It is time to transcend the limits of product-focused innovation and move to a way of thinking that can lead to increased margins for companies and add more jobs to our economy.”