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OPEN INNOVATION AND ITS IMPLICATIONS ON NOKIA IN THE SMARTPHONE INDUSTRY
Vijayaraghavan Narayanan
GGSB – MBA – PT6
28/11/2009
A Marketing Management paper on Product & Service Innovation
Table of Contents INTRODUCTION .......................................................................................................... 2 THE OPEN INNOVATION PARADIGM ........................................................................... 2 The Outside-In Process ..................................................................................................... 3 The Inside-out Process ...................................................................................................... 4 The Coupled Process ......................................................................................................... 5 Hurdles in Implementing Open Innovation ..................................................................... 5 Open Strategy and Open Business Model ........................................................................ 6 NOKIA AND THE SMARTPHONE INDUSTRY .................................................................. 6 Nokia SWOT Analysis ....................................................................................................... 9 Recommendations .......................................................................................................... 10 CONCLUSION ........................................................................................................... 11 EXECUTIVE SUMMARY ............................................................................................. 12 Figures ..................................................................................................................... 13 References ................................................................................................................ 15
2 INTRODUCTION Companies that don't innovate die.1 Due to the rapidly increasing speed of technological changes, innovation which was once solely an internal affair is gradually being transformed into a more fluid process integrating internal and external sources of ideas in terms of products and services. This paper delves into the concept of “Open Innovation” from an academic perspective and follows it up with a real world scenario, where the implementation of these business practices in the Mobile handset industry is discussed from Nokia’s perspective. THE OPEN INNOVATION PARADIGM Kotler (2005) defines innovation as an idea, service, product or piece of technology that has been developed and marketed to customers who perceive it as novel or new.2 New product development goes through various stages (Figure 1)3 which can be an expensive, risky and time consuming affair. Yet, companies must innovate before the competition to satisfy the rapid changes in needs and wants of the customer. Traditionally, new product development had all R&D efforts coming from within the company. In recent years, this closed paradigm is getting eroded due to various reasons such as increased R&D costs, high attrition rates and shorter time-to-market cycles. This has led to the emergence of a new paradigm called "Open Innovation" (also called “distributed co-creation”).4 It advocates that, to remain competitive, firms should be flexible in using external ideas along with internal ones. External ideas can originate from sources such as suppliers, customers, etc. and internal ideas can be brought outside through licensing, joint ventures, etc. Open Innovation (OI) practices have been divided into three categories - the Outside-in, Inside-out and the Coupled process.5
(1) The outside-in process: This paradigm involves the integration of external ideas with internal ones to create offerings which wouldn’t have been possible through internal R&D alone.6,7 These external sources could be the suppliers, the customers, complementary technologies from un-related industries, universities, purchase of Intellectual property(IP) in terms of patents and licenses and listening posts at innovation clusters .8 Involving Suppliers can greatly enhance the product R&D as they usually have more technical knowledge about their components. Suppliers like Magna Steyr are integrated into parts of the innovation process of various European vehicle manufactures.9 OI model views customers as part of the problem solving process and sometimes enables companies to deduce the customers’ needs even before they are aware of them. Universities are also seen as potentially valuable sources of innovation. Many companies such as Intel (‘Lablets’)10 , Merck (Merck Gene Index)11 and BT (through BT Exact)12 have set up networks with universities across the globe to gain from such crosspollination. A survey of 300 senior executives in 2006 revealed universities(60%) to be the biggest external source followed by customers(50%) and suppliers(>45%) .13 Companies like P&G (through Connect & Develop)14 and IBM have been early adopters while others like Siemens have just begun.15 Purchasing IPs (In-licensing) or acquisitions is also seen as favorable method employed by many companies. Companies like Cisco match the R&D output of its competitors mainly by monitoring young start-ups around the globe and involving with them through investments or partnerships which sometimes lead to acquisitions.16,17 Another OI practice called Crowd-sourcing is increasingly gaining popularity. The idea is to outsource a problem or a challenge to the masses in the form of an open call. Solution providers are sometimes rewarded monetarily or through
recognition.18 This model derives from the success of community driven Open source projects such as Linux OS and Wikipedia. Growing internet penetration and technologies such as web 2.0 are key contributors to this model. It has even led to the creation of intermediaries called “Knowledge Brokers”19- Institutions (like innocentive20 and ninesigma21) that aim to bring together firms (called “seekers”) with difficult technical problems and individual scientists or teams (called “solvers”). Not only for-profit firms, but public institutions and Not-for profit firms have also started leveraging these Innovation Networks for the betterment of society.22, 23, 24 (2) The inside-out process: This OI model refers to processes whereby a business generates profits by transferring its ideas to the outside environment. The usual routes taken are outsourcing, licensing and spinoffs.25 It not only saves R&D cost and development time, but also can generate high margin licensing income thereby promoting innovative ecosystems. In cases of insufficient financial or technical capabilities for a project, companies can spin it off into a new venture with help from external investors and can itself become a customer for that venture. Investors take the development burden and the company can reacquire successful ventures.26 Bringing out the idea can also help the company tap into new markets (cross industry innovation) for revenues. IP licensing (Out-licensing) has become a major source of revenue generation and many companies such as ARM survive on this model alone.27 By Out-licensing technology, companies can avoid the cost and risks of product development and still participate in the rewards of a product developed using its technology.28 Many companies with redundant IPs and patents can successfully exploit this approach like Philips, which has developed a thriving licensing business around its more than 60,000 patents.29 Companies such as Cisco use this process to set a technological standard which is seen as a major reason for outsourcing the commercialization of a technology. During tougher economic climates such as recession, the Inside-out approach can yield better results as companies can put their unsustainable R&D projects outside which may eventually benefit the company when the market recovers.30 (3) The coupled process: This paradigm couples the outside-in and inside-out processes and firms usually implement it through alliances and joint-ventures with complementary partners in which give and take is crucial for success. The objective of most companies that focus on the coupled process is to set standards or a dominant design for their products. 31 A recent example is the creation of the Open Handset Alliance,32 a strategic alliance of 47 companies working in related fields with a common objective to develop the next generation Open Source Operating System (OS) for the mobile communications platform. Hurdles in implementing Open Innovation: In spite of the potential of OI communities, when it comes to execution there is a significant gap due to various risks and hurdles involved.33 A few of the challenges include attracting & motivating cocreators, governance mechanism to facilitate co-creation, management of IP rights and sustaining quality.34, 35 A study with 107 companies in 2008, showed that risks such as loss of knowledge (48%), higher coordination costs (48%), as well as loss of control and higher complexity (both 41%) are mentioned as frequent risks connected to OI activities. In addition, there are significant internal barriers, such as the difficulty in finding the right partner (43%), imbalance between OI activities and daily business (36%), and insufficient time and financial resources for open innovation activities.36 Human costs of inside-out process must also be considered where good people are often let go along with the assets they’ve created.37 These factors make it imperative for a company to redefine its business models to ensure the success and sustenance of its OI activities. Open Strategy and Open Business Model: To leverage economic value from OI, companies must change their business models to what is termed as “Open Business Model”. It provides the much desired combination of leveraged cost and time savings during value creation with new revenue opportunities for value capture. 38 It also requires an “Open strategy” which involves balancing the value creation along with the capture of a portion of the value created, instead of losing sight of value capture during the pursuit of innovation. Companies such as IBM and Merck have successfully used this strategy in developing an ecosystem to create value upstream and later capture it downstream. 39 Open innovation allows firms not to perform every function of the value chain (as defined by Porter40) on their own. A detailed study of how successful OI strategies have provided anomalies to the traditional concepts such as Porter’s five forces( based upon ownership ,control and a focus within the firm) call for a substantive revision in these models .41 Figure 2 depicts the new business model of open innovation and its benefits.42 The mobile handset industry was an early adopter of the outside-in OI model with the inside-out process gaining popularity in recent times. The following section discusses this evolution in the Smartphone segment from the perspective of mobile handset maker - Nokia and analyzes its OI initiatives with those of its competitors.
NOKIA AND THE SMARTPHONE INDUSTRY Nokia is a Finland based world's number one manufacturer of mobile devices by market share and a leader in the converging Internet and communications industries with a presence in over 150 countries.43 The mobile handset industry is an R&D intensive industry with many of the OI practices such as in-licensing, out-licensing, outsourcing and strategic alliances being fundamental to a company’s existence. Nokia is one of the few mobile handset companies that has been embracing other methods of OI as well and even proclaims itself to be a consumer led company.44 Established in 1986, the Nokia Research Centre now collaborates on research projects ( in varied fields from nanoscience to radio research) with leading universities, research institutes and other technology companies around the world to create an OI network .45, 46 This has helped Nokia not only to come up with numerous Industry firsts,47 but also present a tangible vision of the future. 48 Dittrich et al. (2007) have discussed the various OI activities pursued by Nokia from 1985 to 2002.49 In the current scenario, one of its important OI activities was the formation of Symbian Joint Venture in 1998 with other handset manufacturers with market creation as its main goal. In 2001, Nokia released its first ‘open’ Symbian Operating System (OS) phone which allowed third party applications to be run on it.50 This marked the beginning of the era of ‘Smartphones’ – Phones that offer advanced capabilities, such as a PC-like OS and Internet access.51 Nokia emerged as a leader in the Smartphone category with 50.8% market share by Q2, 2007 with Symbian OS having a share of 65.8%.52 It had a rich portfolio with phones suited for Business and for entertainment. In the category of Business phones, it already had a healthy competition from RIM (Research in Motion) and in June, 2007 the PC maker Apple, announced the launch of its Smartphone – iPhone.53 It offered a never seen before portable media & communications experience with an elegant, very intuitive yet simple user interface. Its popularity not only stumped the competitors but soon made it an industry standard in smartphones.54 A year after its launch, Nokia’s market share was down to 42.4% with RIM at 15.9% and Apple at 12.9%.55 Meanwhile, in November’2007, Google made its foray into the mobile market by Open Sourcing its OS – Android through the Open Handset Alliance.56 This move portrays the ‘Open Strategy’ approach of Google; whereby it creates value upstream (Android) with an intention of capturing the value downstream (with proprietary applications and online ad revenues). Nokia, which was already taking a hit in the upper-end Smartphone segment from Apple & RIM, played a catch-up act by acquiring Symbian in June 2008 and making it Open Source through the Symbian Foundation - an alliance of various companies including handset makers such as Samsung and Sony Ericsson.57 Since then many companies have joined either of the two, with some such as Samsung and Sony Ericsson being part of both alliances. In July 2008, Apple announced the launch of “App Store” – an online store where third party developers can sell their applications made for iPhone on a revenue sharing basis.58 This move reflected the phenomenal “Thought Leadership” of its CEO, Steve Jobs as it changed the paradigm of a mobile phone sale from a one-time revenue generation model to that of revenue generation throughout its life-time. Apple also saw the availability of a huge number of applications as a much more compelling reason to buy an iPhone. In terms of “Service Innovation” it depicted the OI model, where Apple benefitted from the R&D efforts of external application (App) developers with shared revenues. Within a month of its launch, the “App store” was earning $1 million a day.59 It further cemented Apple’s position as the leading Smartphone in spite of an array of "me-too" devices in the market. The end of Q3, 2008, saw the world economy plunge into one of its worst financial crisis with most developed economies falling into recession but Q1, 2009 results showed that although worldwide, Mobile Phone Sales declined by 8.6%, Smartphones grew by 12.7%.60 Q2, 2009 followed this trend with 6% decline in mobile phone and 27% increase in Smartphone sales. Smartphones generally have higher profit margins and an analyst report showed that Apple & RIM accounted for only 3% of worldwide mobile phone sales in 2008 but 35% of operating profits.61 These reports were further encouraging for companies who wished to venture into this segment by taking advantage of Open Source OS as it lowered the entry barrier (in terms of R&D cost & time) for them.62 Ideally, the “App store” innovation should have had come from Nokia, as it allowed third party applications since 2001, but it never thought of leveraging its full potential until the launch of the online “Ovi store” in May’2009.63 By this time, Apple’s “App store” was almost 50000 apps strong and growing.64 In August, 2009 Nokia made a radical shift by announcing its most advanced Smartphone (N900) based on the Linux OS – Maemo with availability from November’2009. In spite of Nokia’s product strategy of “line stretching” , whereby it offers a wide array of Smartphones for various budgets(albeit at an increased R&D cost),65,66,67 its market share tumbled to an all time low of 39% in Q3,2009 with sales of 1.8 million for its flagship phone N97 compared to 7.4 million for iPhone.68 Nokia SWOT Analysis: A SWOT Analysis of Nokia in the Smartphone segment (Figure 3) shows that its strengths such as financial prowess, heavy R&D investments, a worldwide presence and a wide portfolio help it sustain the leadership position in Smartphones but its inherent weakness of not having a better flagship product along with its late catching up act with respect to open-source OS and applications store have eroded its market share considerably. A big weakness for Nokia is its abject failure in USA which has the largest mobile internet penetration in the world.69 Q3, 2009 results showed Nokia shipments to North America to be less than 3%. 70 A key reason is that Nokia usually sells its phones at full price as compared to others like RIM & Apple which sell in conjunction with Network carriers at a subsidized rate. In terms of opportunity, developing countries such as India and China have been making impressive growths in spite of a tougher worldwide economic climate and Nokia already has a well entrenched market in them.71 Nokia can get a much better response for entry and mid-level smartphones in these countries but this sub-segment is soon to attract a lot of competition as major players like Motorola plan to release tens of smartphones in 2010 with preference towards Android.72,73,74 Among the Open source OS, Android is gaining more acceptance with both developers and handset makers alike as compared to the older Symbian OS which is currently undergoing major updates.75 Since many handset makers are part of both Android as well as Symbian platform, a high acceptance rate of Android may cause them to abandon Symbian. The entry of new players in this segment also poses a threat to Nokia’s market share. Recommendations: Based on these analyses, following are some recommendations that can help Nokia improve its market share – 1. Nokia’s primary objective should be to achieve a sizeable market share in the key region of USA, which is currently the home turf of Apple & RIM. 2. In terms of Services, Nokia should sell on a deferred-income model, i.e. on installments of 12/18 months along with an attractive initial purchase price. Increased sales will generate a positive feedback loop as it will encourage more developers to develop more Apps for it and this will further improve the sales. Nokia can either start a financial services wing for this purpose (which it can spin off later) or consider tying up with some multi-national firm. This move can help it in achieving the above mentioned primary objective. Selling on a deferred income model can lead to reduced R&D costs also as the company can then lower the number of similar models which have less price difference among them and offer the combined features for the same price. 3. In terms of Product, Nokia primarily needs a flagship product which is not seen as a “me too” device and combines revolutionary features with intuitiveness and ease of use. It must include features which the competitors can’t catch up with in short term. Some ideas could be like embedding RFID readers which show immense potential. 76 4. Nokia’s new OS, Maemo has received great reviews and is poised to be the ideal next generation OS for Nokia when compared to the older Symbian OS.77, 78, 79 Nokia can profit by discontinuing Symbian OS from its high end Smartphones and keeping it for its entry and mid-range smartphones. Application development won’t be problem as Nokia is working on a common framework for App development in Maemo & Symbian.80
CONCLUSION Open Innovation is a paradigm which can yield high returns if implemented properly. It requires a company to change its business models to balance the act of value creation with that of value capture in a way that they are sustainable over long term. In a market where all players are leveraging the benefits of OI, Nokia must usher in a revolution to improve its market share. The Smartphone segment has illustrated that product innovation in itself is not sufficient and when coupled with “service innovation”, delivers enhanced value to customers and profits to the manufacturer. Thus companies that invest in OI during all stages of the product lifecycle, stand to gain the most in the long term.
EXECUTIVE SUMMARY In this competitive era, innovation has become the key to survival for most companies. In recent times, it has become R&D intensive with high costs and long time to market, thus forcing companies to look beyond their corporate walls for successful implementation of their product or service innovation projects. This aspect of innovation, popularly known as “Open Innovation” is discussed in this paper along with its three sub-divisions, namely – • The Inside-out process - bringing ideas into the company from external sources. • The Outside-in process - putting internal ideas into the external world • The Coupled process - blending inside-out and the outside-in process. Apart from the benefits of Open Innovation, the hurdles and risks faced in its implementation are discussed along with the need to for companies to change their corporate culture and business models. As a real world scenario an advanced ecosystem, namely the Smartphone segment of the mobile handset industry, is taken where all competitors are implementing various Open Innovation practices. The case of Nokia is analyzed, where in spite of it being an early adopter of open innovation practices; it is facing rapid market share erosion in recent times due to better Open Innovation practices from competitors. The paper concludes with some recommendations to Nokia for improving its market share and emphasizes on the fact that to gain the maximum out of Open Innovation, a company must have flexible business models to implement both the outside-in and inside-out process and most importantly must integrate it into all stages of product development.
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