Collaborative innovation: The case for a new legal framework

As our innovation ecosystem changes over the decades, so does our need to innovate in legal frameworks that encourage high rates of innovation productivity, which is critical to economic growth.

Our current legal framework is still based on a concept of ‘linear innovation’, in which people do ‘long-term research’, some better ideas over time are selected for ‘commercialisation’, and an even smaller number make it to market as true innovations, demanding scale and creating higher-than-normal economic growth.

Although paths of innovation are linearised when recorded historically, the detailed micro-processes of innovation are not linear. The real innovation process requires risk-reducing iterations involving multiple parties over a long period of time.

In this paper, we review the way that the innovation ecosystem has evolved in the US and discuss why we need to develop a new legal framework around innovation. After an abbreviated description of the iterative innovation process, we then examine some principal requirements.¹

The purpose of this paper is to bring the nature of the real innovation process and its implications to the attention of legal thought leaders and professionals, so as to stimulate discussion on how we can work together to improve economic growth.

The innovation ecosystem

Two macro-forces coincided after World War II to set the US on the path of high innovation growth.

First, the industrial infrastructure in the US was essentially unharmed, while the infrastructures of Japan and Europe were largely destroyed. With minimal external competition, US corporations were very profitable and could grow quickly by reinvesting into their own businesses.

The second macro-force was the advent of nation-state investing in research and development, initiated by Compton and Bush from MIT in the 1930s and condoned by President Roosevelt. After the successful application of new science to warfare had proved decisive for the US victory in World War II, Bush extended his strategy to the post-war era, with the vision that government funding of research would become equally important for innovation in the commercial realm. Today, every nation climbing the global economic ladder has followed the US model.

As US companies grew to dominate their respective industry sectors in the low-competition post-war era, reinvestment in their own R&D led to a sequentially-increasing time horizon for innovations and their research efforts eventually overlapped with government research investment.

It is important to note that the fundamental innovations created during this time were created in industry, like in the famous AT&T Bell Labs or Xerox PARC, because only industry had access to the full set of market, implementation and technology elements required for the iterative innovation process.

But, government research investment in universities was equally important to sustain the industrial innovation activity, for it trained the scientific and engineering talent in the ‘right kind of research problems’. These ‘problems’ could be chosen effectively because the virtuous cycle of research education, innovation and growth created a ‘scientific commons’ in which industry innovators could participate freely, introduce important problems and contribute to their solution.

An important, but rarely mentioned, boundary condition for enabling the ‘scientific commons’ was an atmosphere of trust and collaboration. Corporations were not particularly worried about sharing early research results that might benefit other corporations because their operational dominance in their respective industry sectors gave them sufficient security.

Since all innovation processes were internal, corporations could afford to wait and see which ideas were actually likely to head to market and could patent extensively as more market visibility and resources became available. Large patent portfolios could be used to discourage other market segment-dominating companies from moving into their own market segments, but this patenting strategy neither distorted the iterative innovation process nor negatively affected the atmosphere of trust and collaboration in the ‘scientific commons’.

Corporations built on real innovation during the post-war period eventually devolved because of two main reasons. The first was internal. As the vertically-integrated corporations grew ever larger, they became organisationally dominated and bureaucratically inefficient. Most corporations became increasingly intolerant of the way in which the innovation process must occur, which is iterative in nature and across many elements in market, implementation and technology, as well as across organisational boundaries (such as with participation in the ‘scientific commons’).

Instead, they adopted ‘managerial’ linear models of innovation, since these better fit with their organisation. The focus shifted from innovation to development activities, which eventually resulted in diminished payback. This diminished payback from development rather than innovation, in turn, undermined the justification for forward-looking corporate research labs. The internal devolution was enforced by the second, external factor of increasing global competition. Companies concentrated more and more on operational efficiency to sustain profit margins.

However, the long timelines associated with fundamental innovation meant that there was a significant backlog of pre-invested ideas and people that were capable of bringing substantial innovation to the marketplace. The rise of liquidity brought on by the previously-created wealth plus modern finance, especially in the form of venture capital, capitalised on this substantial pre-investment. ‘Entrepreneurial capitalism’ took over almost seamlessly from the era of ‘bureaucratic capitalism’ and new legal frameworks were developed to ease the flow of capital into investment partnerships and promising start-up companies.

Despite the boost from costs previously sunk by bureaucratic capitalism, the initial high returns were very real and quite justified in the sense that impactful innovations were brought to market. It is important to emphasise that the initial entrepreneurs and venture capitalists of this transition were not neophytes, but mostly experienced innovators with decades of experience and expertise. They could make optimal use of the new financial and organisational freedoms to bring the previously-shelved partial innovations to market effectively.

What mostly goes unnoticed is that a paucity of new potential fundamental innovations was added at the start of the innovation pipeline in this period. Now, after the two to three decades of great liquidity bringing any half-promising innovations forward from the innovation pipeline, and after the inevitable series of financially-driven bubbles (telecom, biotech, mortgage, derivatives and so on), the atrophy of our acclaimed innovation pipeline is becoming more visible.

It is interesting to note that, while the real innovation capacity steadily declined in the US from the mid-1980s onwards, the number of patent filings exploded. According to statistics from the World Intellectual Property Organization (WIPO), the number of US filings increased from about 100,000 to about 450,000 per year in the two decades between the mid-1980s and the mid-2000s. This compares to a relatively modest increase during the four decades between the end of World War II and the mid 1980s, namely from 70,000 to 80,000 to about 100,000 to110,000 filings per year.

Interestingly, the number of annual patent filings was nearly unchanged in the various European countries between World War II and the mid 2000s. European countries appear to not have evolved through the entrepreneurial capitalism awakening at the time.

WIPO states: “It is widely accepted that patent statistics are a reliable (although not perfect) indicator of innovative activity.”²

Given the evolution of the US innovation ecosystem as described, the explosion of patent filings during the era of entrepreneurial capitalism must partly reflect the shift in patent use. As entrepreneurial capitalism is extended over multiple organisations, patents have become an important component in defining the interaction between small companies, large companies, universities, investors and government. Essentially, the legal frameworks surrounding innovation shifted to serve the financial industry from the mid-1980s onwards.

We now need to newly align the interests of stakeholders in the current innovation ecosystem with concomitant legal innovation. In order to create solutions, we must first review the innovation process itself in order to lay the foundation for conceiving solutions.

The innovation process

Since any legal framework is primarily concerned with the mitigation of risk, ?we will provide an abbreviated review ?of the iterative innovation process ?through this lens.

In order to build from the human process of innovating upward to understanding multi-person and multi-organisational needs, we must define innovation precisely. We define innovation as “the embodiment of a useful idea in the marketplace”. Innovation is thus much more than science and invention, which may be contributing elements. It is also very different from entrepreneurship, which is just one possible method of business execution during the last phase of the much longer process of innovation.

Any innovation requires the right elements from the three categories of market, implementation and technology to come together successfully. We define these broadly, so they principally comprise all human activity and knowledge.

Specifically, market comprises all current and potential future (unknown) market applications of the innovation, ?and thus all potential market segments ?that could have a need for the innovation or desire it.

Implementation comprises any new or old processes and knowledge to execute in making the innovation real. Elements in the implementation category include, for example: all possible ways of manufacturing; all relevant industry structures and supply chain options; all possible business models and channels to market; all costs associated with the various possibilities of making a product and running the corresponding business; all possible financing options; and the entirety of business-relevant law, including patent strategies.

Technology comprises any new or old technology that allows the innovative idea to exist and enables it to be executed. It thus includes everything that is objectively verifiable, including all scientific and engineering knowledge, from knowledge of how to make fire to the quantum mechanics in your latest electronic devices.

Innovation results from repeated iterations between technology, implementation and market, a process that constantly reshapes an innovative idea and successively removes uncertainty based on practical learning in all three areas until it converges on a profitable business opportunity. This iterative innovation process can run over shorter or longer periods of time, producing incremental or fundamental innovations, respectively (see Figure 1).

 

Incremental innovations run this process over shorter periods of time and fewer elements are considered with less uncertainty in each of the three categories. Incremental innovation can often appear quite linear, especially when there is little to no uncertainty in one or two of the categories. They are more common and are often the small step-changes typical of product development, like the iPhone 5 after the iPhone 4, or yet another internet-based business selling things or connecting people in a slightly different way.

Due to the limited amount of uncertainty, the opportunities and risks for incremental innovations are not too difficult to understand, communicate and finance. Incremental innovations will always occur and the current legal instruments are well attuned to them. However, they do not produce the type of economic growth we experienced during the past century. Returning to such growth requires fundamental innovation, for which we have to renew our innovation ecosystem and, as an essential part of this, create a new collaborative legal framework.

Fundamental innovation requires innovators to increase the number of options, or uncertainty, in each category, so that large uncertainties, but also opportunities, coexist simultaneously in the three categories of market, implementation and technology. In addition, individual elements in these categories change over the long time period of 10 to 15 years in which the fundamental innovation is gestating.

Thus, if an innovator is not considering a large set of possibilities in each category, the chances of finding the right ones to come together over time are vanishingly small. The need to increase options and uncertainty at the start of attempting to create a very fundamental innovation is why research should tackle fundamental problems that could impact many market applications and could be implemented in many different ways. As time progresses, if the research is successful, it has a chance to impact the changing options in market application.

The iterative innovation process ?needs to occur within the practical realities of market, implementation and technology, which require a much better collaboration across organisational boundaries than is possible today. Universities are still operating in a 1970s model layered with a 1990s model of easy-credit entrepreneurship on top, the contribution of which to innovation productivity is insignificant.

The gap between universities and market, and between universities and implementation, is larger than ever. Corporations, which contain some of the market and implementation knowledge, have a technology time horizon of three to five years at best. Neither universities nor corporations are capable of executing the medium and long-term innovation process by themselves, and there are no mechanisms by which they can effectively bridge the gaps between them and do iterative innovation together.

Collaborative fundamental innovation

The legal remnants from the entrepreneurial capitalism phase create a focus on intellectual property, especially patents, as financial assets around which transactions are structured. That may serve those transactions very well, but it can severely interfere with the innovation process. Patents, intellectual property strategy and financing are important elements of implementation, but innovation success requires that these elements be allowed to fall into place, as guided by iterative innovation.

To deal with the potential value of intellectual property far into the future, the venture structure created options on future value to help bridge the gaps between university, company and commercialisation. This structure is not sufficient to increase organisational porosity and interaction at the early stage of fundamental innovation and to refill our innovation pipeline rapidly.

As an example of the problem, university licensing operations have a large downside if the intellectual property of ‘the next Google’ is released at too low an option value. Alternatively, the corporation has a large downside if there is uncertainty about financial options negotiated with the university. If the option ends up being too expensive (because it could become ‘the next Google’), corporate investments placed over long periods of time could be at risk.

Thus, the key interaction between optimal participants in creating future fundamental innovation is being defined by the improbable scenario that the interaction produces ‘the next Google’, largely because current structures force option pricing early in the process. Thus, intellectual property and the current legal structures employed by corporations and universities lead to an irrational outcome.

In exploring solutions to this problem, we evolved an internal university precursor over time into a not-for-profit, Innovation Interface, which can successfully bridge the university-industry gap on an individual project basis while training the next generation of innovators. Although we have gained much real legal experience in this space over the past eight years, each of our cross-organisational collaborations was underpinned by individual trust between hybrid engineers-businessmen. In addition, these innovation collaborations were limited to a two-party structure in one-year contractual increments. To elevate fundamental innovation collaboration to the next level, we need a broader legal framework capable of covering the iterative innovation process in its full complexity.

When executed properly, the iterative innovation process inherently constitutes the correct risk-opportunity assessment at any given moment along the way. What we are lacking are methods of recording the risk-opportunity evolution over time, along with: contributions from various innovators in various organisations; a method of ensuring agreement to the risk-opportunity evaluations; and a method of translating such methods and results into a legally-executable form.

In some ways, there appear to be similarities to the patenting process in the sense that it translates expert information into a legally-executable form, contributions are clearly defined and agreement on the underlying facts is reached between experts during a negotiation process with the authoritative entity (the patent office).

One example of a potential combination of financial structure and legal structure that could solve this problem is to facilitate a marketplace earlier in the innovation cycle. That is, more transactions that value the innovation process and its output as it is occurring over time. Such a process would help to define current value and allow participants to more easily engage with it. Currently, the value of the entire innovation process is only valued, for all participants, at the end of the process (as the idea appears in, or nears, the marketplace).

Whatever the new framework, the ability to plan is of vital importance to businesses, but imposing linear planning on the iterative innovation process would destroy it. Furthermore, a new framework must carefully assess the inherent power and nature of all stakeholders against their roles and contributions. For example, good innovators are extremely rare and there can obviously be no fundamental innovation without them. Motivated intrinsically, they focus on value creation, not value extraction. They will thus always be at ?a power disadvantage to more extrinsically-motivated parties.

During the fundamental innovation process, innovators make extraordinarily large intellectual contributions, especially during the early stages of iterative innovation. An optimised framework ?would encourage innovators to move forward, since the risk involved with ?their work could be more resolved ?(and therefore lowered).

Innovators’ contributions are often unnoticed or are deliberately ignored at a later stage. In his book Pragmatism, William James expressed the inability of humans to properly recall contributions to new theories, but the same applies to innovation.

“Any new theory”, he wrote, “is attacked as absurd; then it is admitted to be true, but obvious and insignificant; finally it is seen to be so important that its adversaries claim that they themselves discovered it”.³

A new legal framework for collaborative fundamental innovation needs to support the optimal unfolding of the fragile iterative innovation process over long periods of time and across organisations, while enabling innovators to proceed without fear that their contributions will go unacknowledged in future.

Massachusetts Institute of Technology Professor Eugene A. Fitzgerald and ?Dr Andreas Wankerl are authors of ?Inside Real Innovation and founders of ?not-for-profit organisation Innovation Interface (www.innovationinterface.org)

Endnotes

1. For a full description of iterative innovation and the innovation ecosystem, see: Inside Real Innovation: How the Right Approach Can Mover Ideas from R&D to Market – And Get the Economy Moving, Eugene Fitzgerald, Andreas Wankerl and Carl Schramm, World Scientific Publishing ?Co, 2011

2. World Patent Report: A Statistical Review - 2008 edition, World Intellectual Property Organization

3. Pragmatism: A New Name For Some Old Ways of Thinking, William James, Longmans, Green & Co, 1907