Corporates, Startups, and Open Innovation in China

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This article was originally published in the first edition of the AmCham China Quarterly, an executive-targeted periodical focused on policy, business, and technology, driven by C-suite perspectives and insights. To subscribe or contribute to the Quarterly, contact our editor: jpapolos@amchamchina.org


Gradually, then suddenly

 

In Ernest Hemingway’s 1926 novel The Sun Also Rises, a character is asked how he went bankrupt. He simply responds, “Two ways. Gradually, then suddenly.”

More recently, this quote has been used to describe how former incumbent corporations have been disrupted by innovative startups. Famous examples include Blockbuster, Blackberry, and Barnes & Noble. Once industry leaders, each has been felled — gradually, then suddenly — by upstarts Netflix, Apple, and Amazon, respectively. This disruption continues today and at an increasing pace. The average company lifespan has dropped from 90 years in the 1920s to 60 years in the 1950s to 17 years in 2018.

But this is old news.

A less recognized “gradually, then suddenly” phenomenon is that of corporations proactively working with external startups. The term “open innovation” refers to a company inviting or seeking new ideas from outside its own organization. At first, only a few large companies had formal programs to engage external entrepreneurs, but now, many companies are running experiments with outside startups. Gradually, then suddenly, all large corporations will soon practice open innovation as a basic requirement of staying competitive.

With regard to open innovation, the three questions firms most frequently ask are:

  • Why work with startups?
  • How can my company engage startups?
  • Which corporations are already doing what in China?

Let’s look at each of these three questions in turn, in order to put together an overview of the state of open innovation today in China.

Why corporations work with startups

Corporations have many reasons to launch open innovation initiatives, but these are the four most common drivers:

  • Early awareness

Corporations work with startups to be aware of innovation happening outside their organizations. Having a direct line to the entrepreneurs shaping the future gives corporations an early warning of emerging innovations that may disrupt their business models. Whereas market research reports rely on past data and are thus inherently backwards-looking, startup founders necessarily look to the future. Open innovation programs offer this critical forward insight, which is especially important in a fast-paced market like China

  • Access to options

Once aware of potential disruptions, corporations can take action. But rather than rely on internal R&D divisions not suited for rapid response to external changes, firms may choose to work with the external innovators themselves. Early engagement with startups enables a corporation to potentially ride the impending wave of change, rather than be inevitably crushed by it. And engaging multiple startups via an open innovation program diversifies risk among several solutions, as opposed to committing resources to developing one in-house solution which may or may not succeed.

  • Talent development

A less appreciated motivation for engaging startups is talent recruitment and retention. For certain functions (e.g. product management, innovation), startup founders and their teams constitute a unique pool of talent. More immediately, joint activities with external startups can provide existing employees with new ideas and perspectives. This is particularly apparent in open innovation efforts that engage very early-stage startups. While these young teams lack any scale meaningful to corporations, they can catalyze the cross-pollination of ideas and even provide connections to future talent.
 

  • Organizational support​​                                                                     ​

A very tactical, yet real, reason to launch individual open innovation projects is to build support for larger projects in the future. When open innovation practitioners are asked what their biggest challenge is, the most common response is internal buy-in. Innovation leaders frequently need to coordinate budgets, approvals, and competing interests within their own organizations. Given how new this practice is, many first efforts at open innovation are not ideal in scale or design but are instead launched as “stepping stones” to gradually garner organizational support for more strategic efforts down the line.


Whether listed above or not, a corporation’s open innovation goals—and their relative priority—influence how it designs its initiatives with startups.

Three corporate models for engaging startups

Corporations work with startups in many ways. In theory, the only restriction is that a collaboration must benefit both the corporation and the startup. In practice, open innovation activities generally fall into one of three general models, each with its own pros and cons:

A. One-Off Activities: Fast & flexible
The first model of open innovation is the single, non-recurring event. Sometimes this can be a series of events, but the key difference from other activities is that the activity is finite. Hackathons (e.g. Mars’ Redefining Retail Hackathon), startup challenges (e.g. Pernod Ricard’s Ask Jerry Challenge), or other innovation sourcing activities (e.g. Sodexo’s Open Innovation Day) are examples of this model.

The advantage of model A is that it does not require long-term resource commitments and is thus relatively easy to launch, especially if local partners are hired to manage implementation. Corporations often utilize this model in their first foray into open innovation for rapid learning, before settling on a more long-term direction. A possible drawback of such “light touch” activities is that they may not be as attractive to more mature startups.
 

B. Ongoing Programs: Diverse benefits
The second model is the ongoing program for startups. This can take the form of a recurring accelerator program (e.g. Microsoft’s Accelerator, Merck’s China Accelerator), a repeating startup competition (e.g. Bayer’s Grants4Apps), or even a physical innovation hub from which to engage the startup community year-round (e.g. Li & Fung Explorium).

Model B is perhaps the most well-rounded, contributing to early awareness, access to options, talent development, and organizational support goals all at once. Importantly, its recurring nature can attract a higher caliber of entrepreneur. The flip side of being a continuous activity is the ongoing resource requirement for headcount, real estate, and other direct program expenses.
 

C. Committed Funds: Long-term investment
The final open innovation model involves committing investment funds for long periods of time. In these cases, corporations set aside funds for investing in startups, either by joining other limited partners in a specialized investment fund (e.g. Alliance Ventures) or establishing their own corporate venture capital (CVC) fund (e.g. BASF Ventures). In China, disclosed capital investment from these vehicles has grown 36-fold over the last five years.

The advantages of Model C stem from signaling long-term commitment to investing financially in startups. This attracts later-stage startups more able to work with a large company at scale. In turn, becoming an early investor into a startup can provide an especially deep insider’s view into future trends, not to mention potential financial return. The disadvantage of this approach is its resource intensity. Besides multi-year fund lifetimes being well beyond the horizon for most executives, the legal set up of such funds can be tricky for multinational corporations, particularly given China’s capital controls.

These three categories do not perfectly represent all possible open innovation approaches, but they do capture the majority of open innovation initiatives in China today.

A snapshot of open innovation in China

To illustrate this in practice, here is a selection of corporations with recent open innovation activities in China mapped out, as of early 2019.

The x-axis and y-axis represent resource efficiency and business value, respectively. Resource efficiency is the inverse of budget, time, and bandwidth required. Business value is the long-term impact on the company’s competitiveness and success.

The ideal open innovation activity is infinitely efficient and infinitely valuable. Graphically, this perfect activity lies in the far upper right-hand corner. In reality, this is not possible. Instead, the curved line represents the “frontier” of what is possible with current open innovation approaches.

The three models described lie on different parts of the frontier. One-Off Activities (Model A) are resource-light, but have limited business value; they lie closest to the lower right-hand corner. Conversely, Committed Funds (Model C) create the most value over time, but are resource-heavy, so they lie closest to the upper left-hand corner. Meanwhile, Ongoing Programs (Model B) lie in between these two extremes, in the middle part of the frontier.

Corporations are engaging startups not only for early awareness, but also for future options, talent development, and organizational support.

To be clear, “open innovation” here is defined as engaging external actors, startups or otherwise. Corporate innovation strategies that do not involve outside startups are not dealt with in this article. For example, activities not included on the map are internal innovation initiatives (e.g. Intel’s Ideas2Reality, SAP’s Labs China, Mars’ Global Digital Innovation Center); innovation service providers (e.g. Plug and Play, Chinaccelerator, XNode); university collaborations (Covestro-Tongji Innovation Academy); and conventional M&A of large companies. These are each valid innovation strategies in their own right.

Beyond the frontier

More and more corporations are engaging startups. They do this not only for early awareness of innovations coming their way, but also for future options, talent development, and organizational support. Most efforts fall into one of three general models: One-Off Activities, Ongoing Programs, and Committed Funds. The resulting map of open innovation in China helps to make sense of which companies are currently doing what in China.

This framework, while simplistic, enables useful discussion around open innovation strategy. For example:

  • Picking a position
    Given our goals, where do we want to be on the frontier? Do we value flexibility or can we commit for the long haul? Who else is in a similar position, and how do we collaborate or compete for startups?
     
  • Path to position
    Can we go straight to our desired position? Or do we need to build organizational support via One-Off Activities first and then “climb the hill” to Ongoing Programs or Long-term Investment?
     
  • Optimizing position
    How do we implement our activities to be on the frontier, rather than at some sub-optimal point short of the frontier? What resources—internal and/or external—can we align to maximize resource efficiency and business impact?
     
  • Pushing the boundaries
    Once in position on the frontier, what can we do to go beyond the frontier? What better ways to work with startups might we invent to further reduce resource requirements and/or increase business value?

It’s worth noting just how many companies, of all shapes and sizes, are already engaging startups in China and adopting open innovation practices. In Hemingway’s quote, we seem well past “gradually” and much closer to “suddenly.” Working with external startups will soon be the new normal for corporate innovation. Then, competitiveness may come from creating better partnership models to solve problems together with startups; not merely operating at the frontier, but expanding it.


This article was originally published in the pilot of the upcoming AmCham China Quarterly, an executive-targeted periodical focused on policy, business, and technology, driven by C-suite perspectives and insights. To subscribe or contribute to the Quarterly, contact our editor: jpapolos@amchamchina.org