Story:
Innovation as a Business: How to Create a Repeatable and Sustainable Innovation Engine
PARC made a radical transformation from a captive research center to a commercial open innovation business. This forced PARC to create a number of new practices in innovation management -- just to survive, let alone prosper. Organizations of all types can apply lessons from PARC’s journey to create a deeply embedded and repeatable innovation capability that is efficient, effective, and accountable for commercial results.
PARC was founded in 1970 and is well known for its many technology innovations such as Ethernet, laser printing, and the graphical user interface, developed from its original charter to create “the office of the future.” But what’s not as well known is that PARC has created a number of business practice innovations since it spun out from Xerox in 2002 as a wholly owned subsidiary. It was a disruptive change from being a cost center for 30+ years to becoming a business with a P&L. In addition to needing a new financial system and business staff, PARC also had to figure out how to position itself within a nascent open innovation marketplace, and articulate what it had to offer to the world.
When PARC first changed from Xerox PARC to PARC, a Xerox company, the original business strategy was to license IP from PARC’s extensive patent portfolio and earn royalties that would fund PARC’s future research activities, similar to how a foundation earns income from an endowment. This strategy was not successful, primarily due to an unpredictable IP licensing market and a lag between when patents are issued and when they become valuable. PARC was not yet truly operating as a business because the revenue model was divorced from the operational activities.
In 2006 PARC shifted to a client services business model tied directly to monetizing and commercializing PARC’s research activities. PARC’s key asset has always been its people -- the entrepreneurial scientists and engineers who love to solve problems and create a meaningful impact in the world. We began to market our researchers to clients to help them solve problems, and ‘see around corners,’ with the idea that clients (both commercial and government) would sponsor existing PARC research that could be useful and financially beneficial to them. Although PARC was now organized as a business, there were still several lessons to learn with this strategy -- namely that most commercial clients were hesitant to pay a premium for PARC expertise, services, and technology that were not ‘de-risked’ sufficiently. While PARC was able to meet its annual financial targets, the revenue stream was lumpy and unpredictable, which was difficult for a research environment where scientists value a stable work environment.
In 2009 PARC made another course correction and implemented a number of important changes that have greatly improved our ability to operate as a sustainable business, and can be useful for other companies wishing to improve the financial returns of their innovation activities:
1. Create an innovation culture grounded in learning and open innovation
As we succeeded in transforming PARC into a predictable business in terms of financial performance and repeatable technology commercialization, it has been important that we do not lose our ability to take risks as a research center. This is a challenge for many companies that focus on quarterly earnings and incremental improvement, and run the risk of being disrupted by new entrants. It is the most common reason companies believe they are as not as innovative as they are capable of being.
To maintain our research-driven culture, PARC adopted a learning-based approach to managing innovation by extending the scientific method of testing hypotheses in our research to project management and evaluation. We ask our researchers to pursue research explorations by validating key technical uncertainties as quickly as possible. We ask our business development staff to create hypotheses for value proposition and validate them with clients early in order to inform the technical objectives and make sure we will create value if successful. Failure is inherent in the process of exploration and learning, so efficiency is paramount. It is important that employees feel that they can try new things and not be punished for failure, and that the culture contains an integral ability to risk, fail early, and correct quickly.
The phrase “The enemy of perfect is good enough” is very relevant at PARC. We’ve had to evolve our culture to work faster, and build Minimum Viable Prototypes (our version of ‘MVP’) that are incomplete but good enough to start engaging with clients in open innovation. We still have to be mindful of creating and protecting core IP, but it is through continual and collaborative engagement with our clients (and their customers, the end users) that we learn how to design, refine, and package the applications of our technologies so they can be incorporated easily into our clients’ products and services and readily adopted by their customers in the market. It’s the repeatable methodology that we’ve valued the most in this process -- for both PARC and our clients. The (wash, rinse, repeat) cycle brings together a diverse group of researchers with domain experts from product/services companies and their customers, and together we are able to challenge existing assumptions and create breakthrough innovations.
2. Foster a ‘real options’ mindset to increase agility
People often ask us at PARC to predict the future (Alan Kay at PARC famously said “The best way to predict the future is to invent it.”) In reality, it’s not necessary to predict the future, but to react to the future faster than anyone else. We’ve learned that the best way to do this is to describe various futures by extrapolating trends based on deep technical expertise and market insight, including a few scenarios that may be unlikely, and then start some innovation projects that anticipate a cross-section of the futures.
We have also learned not to invest too much all at once. Start with small bets and ramp up investment over time. This is the concept behind real options, where you increase investments as you gain more information about key risks, expected returns, and probabilities of success. By ‘being in the game’ with a set of active projects (the options), organizations are better positioned to be able to recognize weak signals in the market and react faster than others by ‘exercising’ a ready option rather than trying to start up a new project from scratch. Another phrase, “Chance favors the prepared mind,” is a good way of describing how a real options mindset can increase organizational agility.
PARC’s water clarification technology is illustrative of the real-options mindset. The Hydrodynamic Separation method was discovered during the course of a prior government funded project on bio-agent concentration. The research team explored a number of possible commercial applications simultaneously by building a small demonstration system to test various types of water samples. By talking with a number of potential commercial partners, the team learned critical information in regards to what was needed in terms of an MVP to prove that the technology could be effective and scalable. As certain applications became clearly more promising than others, PARC then invested more in creating a pilot system that could be deployed in the field for additional testing. Through this process of interacting with clients, we discovered that our original hypothesis for value in terms of water clarification was not as well suited to the technology as particle concentration. What we thought was the ‘dirty’ waste of the system is actually the source of value, which we would have likely missed had we invested a large amount of money in improving water clarification effectiveness at the beginning of the project. Armed with this insight, PARC was able to respond quickly to an RFP from the California Energy Commission, and was later chosen to receive a $1M grant to use this technology in wastewater treatment to separate and concentrate suspended solids for anaerobic digestion in order to generate methane. The ultimate goal of the project is to help wastewater plants become energy neutral. (For more details, see “PARC Awarded California Energy Commission Grant to Treat Wastewater in California”.)
3. Introduce a prescriptive portfolio management framework
In addition to managing each project effectively, it is important to create a portfolio management framework that guides the entire innovation process, from ideation to commercialization. Based on financial portfolio theory, PARC developed a new framework with asset classes represented by portfolio segments’ increasing levels of technical and market risk and an asset allocation of target weights for each segment based on financial goals. By creating clear targets for investment strategy, we created a prescriptive rather than descriptive model that gives us visibility to make course corrections as a complementary analysis of opportunity cost to our regular research program reviews. We track both return and risk-related data that help us monitor the portfolio over time so that we can actively manage projects across segments and start or end projects in order to achieve the targets. (For more details of PARC’s portfolio management approach, see “Managing Research as an Investment Portfolio”.)
Since it is always easier to justify investment to improve current products and meet near-term customer requests, this proactive approach can help companies ensure enough investment in creating business options aimed at new markets or disrupting existing markets. It also increases consistency and transparency in investment decision-making, which empowers employees and gives them a mental model to understand where they should focus their creative efforts. But to be effective as a guiding force, it can’t be too complicated. Here’s one last favorite phrase, “Don’t confuse precision for accuracy.” Focus on the key drivers of value and risk, and use tiers of relative values in your metrics instead of requiring absolutes. When the locally-optimized behaviors of individual employees are aligned with the global optimal for the organization, you end up with a very high-performing workplace.
PARC’s journey has not been easy, and we have needed to overcome several challenges along the way:
The first challenge was in changing the culture at PARC to become more business oriented without losing the special qualities that have driven PARC’s inventive success for more than 40 years. This meant preserving the ability for researchers to start small exploratory projects on the basis of expert intuition rather than requiring full business cases. But what we have instituted is an expectation that researchers should outline a clear goal on what they hope to learn, and outline at least a narrative of how this might lead to a large opportunity in a specific market in the future. This is how we introduced the real options mindset. As progress is made and the investment requests get larger, we ask for more details about the commercial opportunity, including an understanding of the value chain, who would be our partners and why our technology would be valuable to them as compared to alternative technologies and substitutes.
Another important change in our culture has been an increasing expectation that researchers need to engage with customers and users more directly in client projects. As we embraced the ‘Customer Development Model’ popularized by Steve Blank and Eric Ries, our researchers have increasingly gone outside of PARC to participate in field studies with PARC’s ethnographers and engage in participatory design sessions with our clients’ employees and end users. This helps us make sure that we are solving the right problem through learning and iteration, and creating a solution that will be readily adopted.
Not all researchers accepted these changes, so many have left PARC in the last few years. But the great majority who have stayed and our new hires believe that these new principles will increase their probability of creating innovations that will make a meaningful impact the world. And I know many of our researchers have also been recharged by the energy coming out of customer meetings when they can see that their work is valued and appreciated by the people who will benefit.
A second challenge was realizing that we needed to change the mix of staff at PARC in order to operate more effectively as a business. We needed to bring more business professionals to PARC spanning business development and product marketing across our target industries to partner with our researchers to be able to identify opportunities and create technology offerings that clients and partners would find valuable and understand how to consume. A related challenge was understanding what kind of people can work effectively on the business side of PARC. It turns out that personality matters a lot, and it is critical for PARC’s business staff not only to be strong in the core professional skill set, but also be intellectually curious, collaborative in nature, humble, and of course passionate about new technologies.
We have also needed to hire additional technical people with new skillsets, such as software architects who can help us design scalable architectures and APIs for software prototypes in order to develop a sufficiently mature MVP. We learned that even though we do not take our technology to commercial product, it is critical for us to anticipate and minimize the downstream work necessary to integrate our technology MVP into our partner’s products or services as part of our work to de-risk our technology. If we don’t, then we risk not being able to complete a commercial transaction because our potential partner decides there is still too much technical work that still needs to be done and chooses instead to form an internal team or acquire a startup to accomplish the same goal. In addition to hiring additional staff, we are also increasingly engaging outsourced engineering firms (both hardware and software) to build more advanced systems as necessary to engage with partners.
Another challenge has been to decide how much to focus the innovation work at PARC in terms of technical areas versus maintaining the historically broad portfolio at PARC. This is an orthogonal discussion to the financially-based portfolio management framework discussed earlier, and it continues to be an important topic of discussion today. One of the steps that we have undertaken to address this issue was the introduction of a research program model, which was driven by our CEO Steve Hoover when he joined PARC in 2011. We created programs to provide more market focus, particularly where opportunities span technical silos, and to generate critical mass for most of PARC’s research areas to improve commercialization. But by design, we keep about 25% of PARC’s work outside of programs in what we call “Emerging Technologies” to allow for exploration in new areas that might spawn new programs in the future. We also created the role of Program Managers to be responsible for defining and managing a coordinated strategy and roadmap encompassing research, commercialization, and IP, and for the first time, also be accountable to achieve specific revenue targets. Not all program managers are new hires, so some people wear multiple hats, but it has been useful to be explicit what hats people are wearing and their related responsibilities.
We have realized a number of important benefits from these new innovation management practices, in addition to those outlined earlier. First, we have a much deeper understanding of PARC’s business model and greater visibility in our financial performance and the tactical levers that we can pull to adjust course as needed. For example, we consider various deal structures that allow us to defer compensation now in return for more upside later in the form of royalties or equity within the context of our current year financial performance. We have also greatly improved our internal financial systems to be able to track budgets and help project leads understand how to manage projects to achieve a target profit margin. We also learned that we needed a separate role of client relationship manager in order to help project leads to be able to push back on expanding client requests, or ‘scope creep’ in order to preserve margins.
We are still in the process of refining the program model, but it has already created a number of benefits. It has encouraged more collaboration between research areas, to identify larger opportunities that may be beyond the reach of any one area. It has improved our knowledge of specific industries and provided more market perspectives to guide our research.
We also have a better understanding of our innovation portfolio and our ‘big bets’ that we make sure are resourced appropriately. This insight allowed us to make a strategic decision to defer commercialization of one of our most promising new technologies to print structured battery electrodes that have the potential to increase battery storage capacity by 10-30 percent. (For more details, see “Squeezing More Energy Out of Batteries”.) With guidance from an industry expert, we learned that if we invested more of our internal funds to de-risk the technology beyond a half-cell demonstration to a complete rechargeable battery with validating performance data, then we could capture significantly more value. By understanding the comparative return of this project to other investments in our portfolio, it was easier to make the decision to increase investment for this project.
Lastly, with our shift to creating MVPs and offerings that are informed by knowledge of our clients and partners’ needs, we have improved our commercialization transaction close rate by 50% and reduced our sales cycle by more than 50%.
Not every R&D organization needs to be structured as a profit center in order to gain the benefits that PARC has achieved over the last ten years. But the fiscal discipline of operating as a business is a useful forcing function to increase accountability for commercialization as a formal outcome of innovation. Without formally changing into a business, other R&D and innovation organizations can still apply PARC’s key lessons:
- Take advantage of open innovation, both by bringing researchers into the field with customers and users, and by partnering with other companies to gain perspective and new technologies.
- Foster a real options mindset that allows employees to take risks in an efficient and effective way and improves your organization’s ability to detect and react to changes faster.
- Implement a prescriptive portfolio management approach that provides consistent evaluation of diverse innovation projects and proactive direction to employees in their innovation efforts.
Beyond the summary lessons above, I wanted to share a few more lessons learned in our journey of commercializing early stage technologies and culture change:
When trying to bring a new product or process technology to market, sometimes it is necessary to go beyond the normal work of your organization’s place in the value chain and proactively create a complete ecosystem in advance of identifying the killer app in order to accelerate the uptake of the innovation by customers when the killer apps emerge. For example, in PARC’s work in printed electronics, we are working with technology partners to create demonstration systems that will inspire new applications as well as connecting with production partners who can manufacture them at scale. (For more details, see slide presentation “Printed Electronics: Starting to Build an Ecosystem”.)
Open innovation is a marketplace of buyers and sellers of technology options and IP. In order for the market mechanisms to operate effectively, there needs to be clear and open communications between parties regarding the maturity level of the technology being requested/offered, the future payoff if successful, how value will be shared, and how much more investment is needed before bringing the technology to market. This is why the concept of MVP is so important in open innovation beyond its inherent value in innovation more generally.
One final lesson – beyond technology commercialization, the MVP approach also works for change management initiatives. You don’t need to get new initiatives perfect before introducing them. You need to understand what specific problems you want to solve, and then develop an 80% correct solution quickly and implement, learn, and refine it over time as you engage employees.
Many thanks to Sonal Chokshi, Tamara St. Claire, and Steve Hoover who helped shape and expand my thinking over the years and to Kelly Brieger, Michele Nemschoff, Heather Miller, and Amy Hawman for reviewing early drafts of this piece.
PARC Blog post: Managing Research as an Investment Portfolio
Thank you for sharing a great story! I definitely agree with your lessons: openness, portfolio management and real options approach are three essential innovation concepts for the time to come.
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Thanks! I'm glad you enjoyed the story and resonated with the lessons. I just expanded the story so take a look and let me know what you think.
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Thanks for expanding the story, Lawrence.
I think it's a prime example for how to reinvent an organization by successfully introducing cutting-edge concepts and approaches to tackle the open, holistic and emergent nature of innovation. You provide some very important lessons learned for firms on how to become innovative, rather than just being inventive. I particularly embrace the implementation of the customer development / lean startup concept - something I consider increasingly important as innovation initiatives tend to struggle with more unknowns (market, technology).
Many of the points being raised here resonate well with key innovation issues that Tim Kastelle and I have identified in a recent post - so it's affirming to see them "applied" at PARC:
http://www.innovationexcellence.com/blog/2013/02/13/key-issues-in-innova...
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A good repeatable and sustainable innovation engine can help the business be more successful. The key innovations are well elaborated and well explained, many business people will benefit from it. This kind of thinking can really help a lot.
Regards,
Maryann Farrugia
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