How smaller companies can benefit from open innovation

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COVER STORY • Open Innovation: A Key to Achieving Socioeconomic Evolution • 3 How Smaller Companies Can Benefit from Open Innovation Henry CHESBROUGH 1635 words 1 January 2010 Economy, Culture & History JAPAN SPOTLIGHT Bimonthly JAPECO 169 English Copyright 2010 Japan Economic Foundation (JEF) All Rights Reserved.

PART 1. Growing Importance of SME Innovation In recent times there has been alot of research on the phenomenon of "open innovation." Open innovation is defined as "...the use of purposive inflows and outflows of knowledge to accelerate internal innovation and expand the markets for external use of innovation, respectively." The benefits of opening up the innovation process are widely accepted among large firms, e.g. Philips, Xerox, Eli Lilly, BASF, and Procter & Gamble(P&G). The benefits of open innovation are also widely accepted in the software development community. Despite these research streams, however, there has been little discussion about the benefits (and risks) of open innovation processes in small and medium enterprises (SMEs). And there are reasons to think that open innovation affects smaller firms differently from large firms since smaller firms lackthe resources and often lack strong protection of their intellectual property. How can SMEs manage these constraints and participate in open innovation effectively? This is not just an important theoretical question. SMEs are of growing importance for an economy's innovative capacity. SMEs have increased their R&D budget faster than the largest firms, and now play an increasingly important role innational innovation systems. Chart 1 shows the growing importance of small firms in industrial R&D spending during the last 25 years in the United States. Large firms with more than 25,000 employees were responsible for 70% of the industrial R&D spending in 1981. Their share shrank to 38% in 2005. In contrast, small firms with fewer than 1,000 employees increased their share from 4% to 24% duringthat period. As a result, large firms are still very important in industrial R&D because their share is still very big (38%) and the amount of R&D spending in large firms increased from $21,168 million in 1981 to $84,983 million in 2005, a factor of 4. However, the increase in R&D expenditures of small firms was even more impressive. Firms with fewer than 1,000 employees spent $54,473 million in2005 compared to $1,317 million in 1981, a factor of 40 increase. So SME R&D spending overall has grown 10 times as fast as large-company spending over these 24 years. Open Innovation Challenges for SMEs Given their growing importance, how should SMEs address the opportunities and risks posed by open innovation? SMEs have some structural disadvantages when it comes to open innovation. They oftenlack many of the capabilities necessary to identify, transfer and absorb external ideas and technologies effectively from outside into their firms. The most important structural deficiencies of SMEs posed by open innovation are: First, lower absorptive capacity: SMEs typically do not have the ability to support dedicated resources and personnel to build structures to identify useful externalknowledge. These structures include technology outposts in innovation "hotbeds" (such as Hitachi's office in Dublin or Nokia's lab in Palo Alto); university liaison managers to access emerging university technologies such as IBM and Intel have created; and technology scouting groups that seek out promising technologies, such as P&G has created. Second, SMEs frequently lack the ability to absorb externalideas and technologies, even when they are initially identified and transferred. Rarely are external ideas and technologies fully formed upon transfer. Instead, they require substantial modification in order to effectively address a commercial need. Many SMEs do not have personnel with the required scientific background to understand, absorb and exploit the

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