While the innovation prowess of the top-performing companies are well known, the “big business” side of the market only represents one-third of the $30 trillion dollars in private sector gross receipts. The mid-market, representing another third, is largely defined as firms with annual revenues of over $100 million but less than $3 billion. As a whole, this slice of the U.S. economy represents roughly $10 trillion in gross receipts and nearly 30 million jobs.
Although the pitch for open innovation has largely focused on the need for large organizations to use external innovation to improve their innovative capabilities, this view overlooks the reality that innovation is not perceived as a life-or-death activity (references to Kodak notwithstanding). While open innovation brings added value to large businesses, large firms have generally maintained or increased their R&D spending over the last two decades, meaning that they are not dependent on external sources of innovation to sustain their product pipelines. Mid-market firms, however, do not share in this benefit, as their share of R&D spending has decreased while maintaining their dependence on internal innovation.
As such, while R&D spending has increased over the last two decades, the share of firms increasing spending has decreased. This means that R&D and other innovation activities have become more concentrated within top performing firms. In the long-term, this leaves mid-market firms vulnerable to disruption from both the high and low ends of the market, as they cannot match the R&D spending of larger competitors or afford to disrupt their existing revenue streams with new business models in the same way that growth-stage startups aim to.
R&D spending tends to understate the pressure mid-market firms face from larger competitors, as R&D budgets are typically one of the first things cut when firms predict difficult horizons. While R&D spending decreases don’t have an immediate impact, spending has a strong correlation with future firm performance, and as such, firms are exposed to a growing innovation gap between large and mid-market firms.
The Benefits of Technology Ecosystem and Open Innovation
Given the decreased affordability of mid-market firms to compete dollar-for-dollar with large enterprises, firms need to invest in processes that expand the breadth and depth on their innovative capabilities without driving costs. More importantly, heavy R&D investment is not a solution for mid-market firms given that while R&D spending is correlated with performance, there is no guarantee that any one project will pay the necessary dividends to improve firm competitiveness. Large firms benefit from vast R&D budgets and stable revenues that can easily absorb R&D failures, while mid-market firms do not have this type of flexibility.
Open innovation creates a viable path for mid-market firms, as it allows them to tap into the creative energies and R&D capabilities of smaller and more specialized firms without heavily investing in their own R&D projects. Furthermore, an open innovation approach allows firms to identify projects that have already shown viability and can benefit from the scale and funding available to mid-market firms. This helps reduce the risk of heavy investment in projects that cannot be viably commercialized, as this often appears in earlier stages of research.
Given the reality that open innovation often depends on a multidisciplinary approach, innovation teams at mid-market firms can establish innovation networks with the depth and breadth of research activity that can help achieve a greater level of R&D intensity and innovation than the firm could achieve internally. More importantly, by off-loading intensive R&D activities to more specialized partners, mid-market firms can specialize in areas where they can better compete against larger firms with heavier R&D investments.
Rather than just benefiting against competition with larger firms, open innovation helps enable mid-market firms to compete against smaller, nimbler startups. Given the nature of startups, mid-market firms have difficulty matching the creativity and rapid decision making that can occur within smaller firms that do not have meaningful management hierarchies. As such, by investing in startups and innovations made by institutions and other firms, mid-market firms can absorb any successful innovations that arise without risking their existing business models.