Gary Hamel talks with Henry Chesbrough on Open Services Innovation

Gary Hamel: What does it mean for an organization to be open?

Henry Chesbrough: I came to open from seeing what happened to organizations that were closed. One formative insight came from watching Xerox and its Palo Alto Research Center. There was all this phenomenal stuff that came out of these research labs at Xerox -- the mouse, the graphical user interface. But as you know, most of it did not make money for Xerox.

It actually went and made a whole bunch of money for other companies. And the problem was that Xerox, for all of its capabilities was, at that time, a very closed company. meaning that they did everything in the copier and printer businesses internally inside of Xerox.

So the first and most fundamental part about being open, seems to be leveraging the tremendous distributed pool of knowledge that exists outside your organization and that no matter how good you are, no matter how big you are, there are too many good ideas and good people outside your organization to try to do it all yourself. Instead, build your innovation process with the founding principle that to be successful in a sustainable way, you're going to have to connect to and leverage and make use of external ideas in your business.

And then the other half of being open is some of the stuff that you work on, you're not going to use. And instead of keeping that bottled up in your own organization, create processes to let those things go to the outside for others to make use in their business. Then maybe there's a way you can hitch a ride either in terms of an equity stake or some technology grant backs so that you get access to the improvements that they make in their R&D for free. These are ways that you can build your business or build a new revenue stream off of your ideas that you're not going to use in your business that others could use in theirs. So this is kind of where I start from when I think about this idea of open.

Gary Hamel: Many managers, when you start to talk about what it means to be open, say they still have a profit-and-loss responsibility to shareholders. The firm is still trying to create an advantage, something that's proprietary. How do those ideas fit together?

Henry Chesbrough: This question of how do you make money in an open world is a really important question. And there is something of a schism on this very point. If you look at open source software, for example, there's one school of thought that says software should be free and licensing regimes like the General Public License mean that everything that is contributed and used, you have to contribute back to the community so that everybody has equal access to all of the invention and intellectual property.

Opposing that are the people who believe in open source but through licenses like Linux and others where you can use open source and make improvements to it that you don't have to give back to the community. In this second branch, there is the opportunity to create things that are more proprietary, that allow you to create a differentiation, some margin that you can return to your shareholders.

Closer to my own research, one of the things that I find is it's the business model that allows you to convert the latent value in your technology into realized economic potential in your business. And the business model is a way of both creating value within the system that you're trying to build, but then capturing at least a piece of the value somewhere in that for yourself precisely so that you can reinvest, sustain your position economically, attract investment, give investors a return on it. The schism that existed in open source still exists in the open innovation academic community. I'm on the side that says we actually need to make some profit somewhere in the process, though others don't share that belief.

Gary Hamel: You know, there are a lot of interesting examples obviously of companies that have been open. I think of the recent example of Netflix running a big contest to get ideas to improve its prediction algorithms. Then there's PepsiCo, its Frito Lay division that held a contest for people to create advertisements for Doritos. These models seem to rely on the willingness of people to contribute their talents for free. And obviously in some of these cases, there's some small kind of reward that's offered, some bounty. But how do you see this playing out over time? Are people going to be willing to give all of this give these ideas to get involved and for the sheer joy and contributing and creating? Or are we going to see folks doing this as maybe we get better mechanisms at tracking back who had that idea and how unique is it and how much value did it create. Are they going to expect kind of more of that total economic pie that comes out of the whole business model?

Henry Chesbrough: This is an area -- the motivations for people to participate and engage in open innovation from the outside -- where we've learned a lot in the last few years, not only from my own research but from many other people as well. And I think the best way to think about it is there are at least two currencies in play. Of course there's the currency of money. And many of the companies that are trying to enlist these armies of people do offer some sort of a prize as an incentive.

But of course for every person that gets the prize, there may be dozens of other people who also do a lot of work who don't win that prize. So they've invested that effort and didn't get any money as a result of that. Fortunately, there's a second currency in play here. And that's the currency or reputation. Many of these projects not only announce the winners but they also announce the finalists or the people who get past a certain threshold.

In open source software projects like Linux and others, you can actually see the code and see who contributed what pieces of that code. So there are abilities to establish one's reputation through these voluntary participatory activities. And that, I think, is a more sustainable force even when you don't win any money whatsoever. I think we all like the feeling of participation.