Research Roundup: The ‘Flip Side’ of Open Innovation, Productivity Losses from Bad Weather and Assessing the Risks of Outsourcing

Open innovation is gaining in popularity, but when should companies be concerned with protecting their own knowledge? Most people expect bad weather to negatively impact business conducted outdoors, but what are its implications in industries where work is primarily done inside? How can companies use risk management techniques to better assess the potential downsides of hiring contract or temporary workers? Wharton professors Felipe Monteiro, Gerard Cachon and Peter Cappelli, respectively, examine these issues — and what they mean for business — in recent research articles.

Accessing External Knowledge versus Protecting Internal Knowledge

“A lot of people have been writing about open innovation,” says Wharton management professor Felipe Monteiro. A typical example, he adds, is Procter & Gamble’s Connect + Develop strategy, which encourages collaboration with outside organizations as a way to bring new products to market faster and more efficiently.

While the P&G approach “has gained a lot of traction,” Monteiro notes, it also raises questions about whether, and when, companies should be concerned about protecting their own knowledge. Monteiro’s research into this issue has led to a paper titled, “Does Strategic Protection of Knowledge Undermine the Effectiveness of External Knowledge Sourcing?” co-authored with professor Michael Mol from the Warwick Business School, and professor Julian Birkinshaw from the London Business School.

In their paper, the authors note that external knowledge sourcing, defined as “the process by which managers identify and gain access to relevant knowledge being created by other organizations,” is critical to a company’s innovation strategy, helping them reduce costs and time in innovation cycles as well as add new technologies, among other benefits.

Also critical, however, “is the importance of protecting a firm’s knowledge base, particularly when it engages in inter-organizational relationships,” the authors write. Given that most organizations are “likely to access external knowledge and seek ways to protect their own internal knowledge simultaneously,” the authors emphasize the need to “better understand how pursuing both strategies at the same time affects an organization’s innovation performance.” In other words, how do these two strategies — accessing external knowledge and protecting internal knowledge — interact with each other?

“The whole argument of our paper is that if you want to be open and to access knowledge from other companies — but at the same time you decide to protect your own knowledge in a strategic way — you will end up” losing the benefits of reciprocity you hoped for from the knowledge sharing, says Monteiro. “So there is a mixed message here. You want to access external knowledge but, at the same time, you want to strategically protect your own knowledge.”

The most common type of strategic protection is secrecy. As the authors note in their paper: “Unlike legal protection mechanisms which force firms to disclose their technological activities, strategic protection relies on the ability of firms to keep their secrets, indeed, secret. It is this strategic use of organizational procedures to protect knowledge that is likely to generate tensions with a firm’s external knowledge sourcing strategy.”

Furthermore, the authors find that the more a firm emphasizes strategic protection of its knowledge, “the more difficult it will be to build the necessary levels of trust and reciprocity with external parties,” and therefore “the less effective [a firm's] external knowledge sourcing will be.”

The authors also point out, however, that with new technologies continually appearing, there are ways to access external knowledge — such as through licensing agreements — where this kind of strategic protection does not harm “trust and reciprocity” or hurt innovation.

One other area explored by the authors — who based their data set for this research on 3,841 questionnaire responses across two versions of the United Kingdom’s Community Innovation Survey — is the relationship between strategic protection and external knowledge sourcing with regard to private firms versus public entities.

Firms can access knowledge in different ways, Monteiro says. One significant path is the “mutual exchange” of information, such as might occur between two professors at two different universities who decide to collaborate on a new course. “There is an implicit expectation from both parties that knowledge will flow,” notes Monteiro. “It is a two-way street, and it is a situation where being secretive can harm trust and reciprocity.”

Now imagine a situation where you can access knowledge through a licensing arrangement. Here, there is no harm to trust and reciprocity because there is no expectation that knowledge is being mutually shared — and therefore no issues around strategically protecting knowledge. Instead, knowledge is being exchanged for money. “It’s a simple, conflict-free transaction,” says Monteiro. “It’s not that trust and reciprocity aren’t important. It’s that my decision not to tell you what I’m doing doesn’t hurt our relationship because it is based on my paying you [for a specific licensing deal] rather than both of us sharing our knowledge.”

The distinction is important, Monteiro adds, because much of the current research on protection refers to legal protection, such as copyrights and patents, which create no tension between partners. “But strategic protection is a very different kind of behavior. It means I am not telling you what I am doing. I am keeping it secret. That’s what creates the tension.” Companies, of course, are free to choose the way they access knowledge. If secrecy is key, then perhaps the right way to structure knowledge access is through licensing rather than, for example, a partnership, Monteiro suggests.

In their discussion about the distinction between private and public partners, the researchers initially believed that when one is dealing with public entities, there is less conflict “because these entities have their own mission of sharing knowledge…. Scientists at a top university, for example, would be willing to disclose what they are working on,” without necessarily expecting that their sharing would be reciprocated.

What the researchers found, however, is that the benefits of accessing external knowledge are actually hampered in formal partnerships with both public and private partners. “Our original hypothesis was that public entities wouldn’t care if you didn’t share,” says Monteiro. “They would share anyway. That holds true in an informal setting” — where, for example, two people are simply having a conversation in a conference and knowledge is exchanged during its course. “But contrary to what we thought,”, it does not hold in a formal setting. “Public entities behave the same way as private entities. They are concerned if you are being strategically protective. It can have a negative impact.”

The negative effects of being strategically protective are stronger the more active a firm is in its external knowledge accessing, the researchers conclude. For example, for firms with very high levels of partnering, using strategic protection decreases the likelihood of innovating by 5%. And for firms with “very high levels” of knowledge sourcing, using strategic protection decreases the likelihood of innovating by 8%. In other words, the authors write, “using strategic protection can indeed undermine the effectiveness of external knowledge sourcing.”

Research shows that “if you access external knowledge, you are more innovative,” says Monteiro, and that by “protecting your own knowledge, you are also more innovative. So looking at those two results separately, it’s a good thing to do both to increase innovation. But our main point is, what happens when you do those two things at the same time? Do they interfere with each other? We argue that they do,” and they interfere the most when two “organizations have very strong expectations of mutual knowledge exchange.”

The results of their research are most relevant to those industries that are active in external knowledge access, says Monteiro, citing the pharmaceutical and biotech industries first, followed by telecommunications, electronics and fast-moving consumer goods.

In summarizing the takeaway from the research, Monteiro and his colleagues emphasize that companies should keep accessing external knowledge through partnerships, licensing and so forth, but that they should also be aware of “the flip side of open innovation. Knowledge access and strategic knowledge protection are not isolated,” the researchers note. “They interfere with each other, and in certain situations this interference can undermine the benefits of open innovation.”

The Effects of Stormy Weather inside Factory Walls

A rainy day — or worse, a hurricane or blizzard — can cause major hits to productivity, and consequently, profitability, in industries such as construction or farming. But does bad weather have implications for industries where work is primarily done indoors? In a recent paper, “Severe Weather and Automobile Assembly Productivity,” Wharton operations and information management professor Gerard Cachon, Columbia University professor Marcelo Olivares and Wharton Ph.D. student Santiago Gallino found a link between output at auto manufacturing plants and the weather in the area where the factory is based. By studying weekly production data and weather reports for 64 U.S. plants over a 10-year period, they observed that severe weather was linked to annual yield reductions that ranged from 2% to 11%.

“It’s intuitive to assume that people working outdoors are going to be influenced by severe weather,” Cachon says. “But what hasn’t really been looked at is the impact of severe weather on production indoors.” The researchers chose to look at the automobile manufacturing industry because there was a sizable amount of easily accessible data and because “auto manufacturing takes place at many different locations in the country, and each [locale] has its own different weather patterns. That creates a natural experiment.”

The researchers examined the output effects of high wind, fog, rain, snow, extreme cold and extreme heat. They found that just one day where winds were strong enough to prompt a caution advisory by the National Weather Service resulted in a 26% drop in yield — “comparable in order of magnitude to the estimated productivity drop during the launch of a new vehicle,” according to the paper. A plant in Arlington, Texas, lost only 2% in production a year due to weather. The factory that lost the most output due to weather was located in Lordstown, Ohio, which experienced an 11% annual decrease.

“The losses are substantial enough that a company might want to consider [climate] when choosing a location for a new facility,” Cachon notes. “If a company is deciding between a location in Alabama and one in Michigan, for example, many firms would consider each state’s labor policy and its proximity to suppliers. Both of those are legitimate factors, but … if you take the same plant in Michigan versus Alabama, you may produce less out of the Michigan plant because you’re going to have more days of weather disruption.”

Beyond considering weather in location decisions, Cachon suggests that automakers could also refine their supply chain operations, given that some of the productivity losses likely come from difficulty receiving inbound shipments due to poor road conditions. Most plants use a “just in time” approach that involves carrying a limited amount of inventory at any given time. “I’m not advocating that [plants] scrap ‘just in time’ completely. But what they need to think about is if they do run very lean with inventory and they ignore the weather, they’re going to experience substantial productivity losses,” he says. “I would think about the idea of having somebody at the company predicting the weather each week and adjusting deliveries based on that forecast.”

The current research did not identify the exact root causes for each factory’s weather-related output losses, which could include delayed inventory shipments, widespread employee absences or a lack of climate control inside the plant. Cachon identified this as a possible area for future research, in addition to examining severe weather’s effects on other “indoor” industries, such as health care or consumer goods manufacturing. He also notes that debate on global climate change includes warnings of rising temperatures worldwide and a possible increase in severe or extreme weather events. “It will be hard to forecast where the aggregate impacts will be, but [the research] is suggestive that climate change will not just influence agricultural or outdoor workers, but may very well have an impact on other areas of the economy people previously thought of as relatively immune to climate,” Cachon says.

Applying Risk Management Tactics to Outsourcing

“Outsourcing” or “sourcing” are widely known code words for the practice of contracting to use lower-cost workers in assembly plants or call centers outside the U.S. Yet outsourcing is no longer just about contracting for low-wage labor in Asia or in other distant locations, notes Wharton management professor Peter Cappelli in his paper, “HR Sourcing Decisions and Risk Management,” published in the October-December 2011 issue of Organizational Dynamics. The outsourcing of HR tasks now occurs in about 90% of all U.S. organizations, the Human Resources Outsourcing Association reported. “Most people would be stunned if they totaled up how much of the key work in their companies is being done by people who are not formal employees,” says Cappelli.

But many corporate managers fail to assess the risks of hiring contract or temporary workers, Cappelli notes. Instead, companies are merely “chasing low cost deals” when making decisions about outsourcing. They rarely apply the lessons of risk management to “the practical question” of “how to make sourcing choices in an informed and effective manner given the type of risks” they face, Cappelli writes in his paper.

According to a January 2012 survey by the American Staffing Association and Careerbuilder, 36% of American firms will hire contract or temporary workers in 2012, up from 34% in 2011 and 28% in 2009. In addition, the survey reports that 35% of American firms are operating with smaller staffs than they deployed before the recession, relying on many contract workers in the U.S., not just abroad.

Rising operational costs cannot be the only criterion for deciding to outsource — whether from a foreign or domestic contractor — nor can conventional advice to retain internally those functions associated with your “core competency,” while outsourcing other less essential functions, says Cappelli, warning that “when so many businesses use consulting firms to define their business strategies and search firms to pick their leaders, the idea of defining a priori what a ‘core’ task is may prove impossible.”

Cappelli suggests instead that managers introduce thinking from risk management to inform their judgments about how to choose sources and how to hedge their bets against the risk of failure. “Beyond considerations of lowering costs, there are two main issues that should drive how we see sourcing choices,” he writes. The first consideration involves reliability. The second is responsiveness. Will the products get produced on time at a competitive price and at a standard level of quality? And will the right products reach your target at the right time?

Given the increasing competitiveness of global markets, any failure to deliver key outsourced components in a timely way — or to supply components of the highest quality — can lead to a manufacturing shutdown that winds up costing a company vast sums of money. Last year’s unprecedented earthquake and tsunami in northern Japan disrupted usually reliable supply chains from Asia to North America, upending production schedules for many products assembled with high-quality components supplied from Japan.

Although risks can never be entirely eliminated, companies can use tactics for alleviating them, says Cappelli. A good place to begin is to think about risk management more systemically. “Use outsourcing tools in a way that mitigates risks,” he notes. Managers should keep in mind that “there are cost-effective [methods] to live with the high levels of risk” involved in making decisions about sourcing.

In his study, Cappelli points to the work of operations research scholar Brian Tomlin from Dartmouth’s Tuck School of Business, who categorized two kinds of methods for approaching sourcing-related risk-management problems: “mitigation tactics,” which take place in advance of those problems, and “contingency tactics,” which take place after those problems occur.

Mitigation tactics generally do a better job of handling problems, says Cappelli, but they involve higher “upfront” costs than do contingency tasks. On the other hand, “contingency tactics are less costly but, because they are only used after a problem arises, they are usually not as effective when they are deployed.” To further clarify the contrast, Cappelli employs metaphors from the world of medicine, in which mitigation tactics might be the equivalent of preventative medicine, whereas contingency tactics would include emergency room medicine that comes into play only after specific problems arise.

Any sensible strategy for mitigating the risks of outsourcing should involve a mix of the two approaches, notes Cappelli. A human resources example of a mitigation tactic for a problem associated with employees who are chronically absent could be to maintain a staff of ‘relief workers” to step in and replace them on an assembly line or in other lower-skilled jobs. “Preventing problems obviously is better than dealing with them after the fact, but often is not worth the cost,” Cappelli writes. “In short, we use mitigation [in this case, preventative medicine] for some risks and contingency [in this case, emergency medicine] for others.”

Sourcing issues can also be compared with inventory issues, adds Cappelli, in that keeping a lot of back-up personnel on hand in case of emergency is like “carrying a lot of physical inventory” in case of a breakdown in your supply chain. Just as having excess inventory is expensive, so is holding a lot of HR back-up in the form of senior executives who can step in for a CEO or other top leader who is forced to leave the company due to illness or some other circumstance. It is “prohibitively expensive” for a football team to hire a back-up quarterback who is just as good as its starting quarterback, says Cappelli, and it is too expensive to hire a replacement CEO who is every bit as good as the starter, and then ask him or her to wait idly on the bench.

Like so many management decisions, Cappelli notes, managing the risks of outsourcing involves making a series of trade-offs based on making calculations that specific events are more likely — or less likely — to occur, given the specific conditions affecting your company. Whatever the sector or size of the company, a common trade-off needs to be made between reliability and responsiveness: “Outsourcing [a function] could promise you greater reliability,” Cappelli says. “But if you want to do something different, you will pay for it” if your company is consequently unable to respond quickly to changes in market demand.

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