Bringing Open Innovation to Services

In recent years, open innovation has been changing the way many companies think about developing products. But open innovation can and should apply to services, too.

The late Harvard Business School professor Theodore Levitt pointed out that customers often do not want the product itself, but rather the effect that the product produces. In his famous example, customers do not want a drill; they want the holes that the drill will make. Peter Drucker made a similar observation: “What the customer buys and considers value is never a product. It is always utility — that is, what a product does for him.”

Thinking about your business as a service business requires embracing Levitt’s and Drucker’s approach to the customer.

How open innovation applies to services

In the open innovation model, there are two complementary kinds of openness. One is “outside in,” in which a company makes greater use of external ideas and technologies in its own business. The other kind of openness is “inside out,” in which a company allows some of its own ideas, technologies or processes to be used by other businesses.

Bringing the Outside In: LEGO

Some companies, like LEGO, have had great success in letting customers create designs. In LEGO’s case, an early example of this phenomenon was LEGO Mindstorms, in which the company included programmable motors with the plastic parts. Someone hacked into the software that came with the motors and made unauthorized modifications to get the LEGOs to perform more functions. Initially, the LEGO people thought that this was illegal and should be stopped.

After further consideration, the company reversed course. It opened up its software so that anyone could modify it and watched what customers decided to create. One outcome from this radically open approach was that an entire middle-school curriculum was developed in the United States to teach children robotics, using LEGOs. Competitions were even created in which a set of challenges were given to all competing entrants. In this way, LEGO products have given rise to a services industry focused on middle-school science and technology education.

Taking the Inside Out:

As Amazon grew increasingly successful, it began to partner with large retailers that wanted their own websites to offer merchandise. The retailers realized that Amazon knew a lot about running a retail website and wanted to hire that experience and put it to work for themselves.

Amazon could have treated its expertise in this area as a trade secret and refused to offer its knowledge to others. Instead, Amazon saw a new business opportunity to create more value from its knowledge of Internet retailing and website infrastructure. Amazon helped third-party retailers develop their own websites. Then the company went further, offering to host these third-party sites on its own servers, thus becoming the infrastructure supplier to those retailers. In some cases, Amazon would even perform the merchandising and fulfillment portions of the transaction for the retailer. This was a powerful way for Amazon to get paid for its knowledge — taking the infrastructure it had built for itself out into the marketplace so other companies could utilize it.

How to foster open service innovation

Granted, it isn’t easy to move your company toward open service innovation — particularly if you have had a product-focused company. Focusing on the value to your customer is the right way to start the journey toward a more services-oriented approach to your business.

Work closely with customers to develop new solutions. IBM has a program called First-of-a-Kind. The customer and IBM both agree to enter into the project, with both sharing the knowledge that comes out of it. The customer gets a good solution to its problem ahead of competitors, while IBM gets the right to reuse the solution in selling to other customers.

Focus offers on utility, rather than the product. Xerox has a services program called managed print services, in which the company offers to manage all of a customer’s copiers and printers. The customer pays only a fixed price per page of output, while all of the acquisition, installation, operation, maintenance and replacement activities are managed by Xerox. Levitt would no doubt have approved: People don’t really want copiers, they want copies. Xerox’s offer also changes what was previously a fixed cost into a variable cost for the customer. It is more capital-efficient for the customer and provides a better career path for employees previously charged with managing copiers and printers in the customer’s organization.

Embed your company in your customer’s organization. United Parcel Service offers to take over the entire shipping function of its customers, so that UPS would handle all of its customers’ shipments, whether they go by UPS, the U.S. Postal Service or even FedEx. In the process, UPS sees a great deal more of its customers’ processes that require shipping. This provides new customer insight for new services by UPS. For example, the company now offers its customers logistics help with inbound supplies from the company’s supply chain. Previously, UPS had no visibility into the customer’s supply chain. With the new services offering, it now can offer new services, increase its share of wallet with the customer and find new sources of revenue for itself.

As companies like IBM, Xerox and UPS are discovering, services help unlock the utility customers want from a product. When you provide real value to your customers, they are less likely to switch to competitors that offer a slightly lower price for the product. Services also differentiate you from your competitors. When you get to know your customers’ problems and processes better, you will gain new knowledge for new improvements and services that your competitors won’t even know about. Innovating in services is an important route to new revenues, increased margins and happier customers in a services-led economy. And that will bring new growth and more jobs to our economy in the process.

This article is adapted from “Bringing Open Innovation to Services” by Henry Chesbrough, which appeared in the Winter 2011 issue of MIT Sloan Management Review.