Organizing for Innovation: When Is Virtual Virtuous?

Many business thinkers have extolled the wonders of networked or virtual corporations where core competency activities are retained but all others outsourced or acquired through strategic alliances. As with most ideas, this one has been over-applied and important nuances missed. Chesbrough and Teece, in this article originally published in 1996, warn of the downsides of virtual corporations, especially with regard to their innovation capabilities. Joint ventures, alliances, and outsourcing, the authors grant, can contribute to innovation capabilities. Without a guiding framework, however, this approach can be strategically dangerous.

The authors present a framework to help managers determine when to innovate by going virtual, when to form alliances, and when to rely on internal development. The ideas of Ronald Coase, who pioneered economic thinking about the size and boundaries of corporations in terms of transaction costs, are not mentioned but the authors do carefully analyze the relevant factors.

The central issue is the tradeoff for a virtual corporation between incentives and control. The authors distinguish between autonomous innovations (can be pursued independently of other innovations) and systemic innovations (whose benefits can be realized only in conjunction with related, complementary innovations). This distinction has vital implications for organizational design. Autonomous innovations can be pursued effectively by virtual corporations, but system innovations will suffer from each party’s dependence on other parties over whom they have no control. Chesbrough and Teece run through a Coase-style analysis of the reasons for this in terms of information transfer, coordination, and codification.

The authors find that the virtual companies that have endured are at the center of a network that they use to leverage their own capabilities. (Such companies are the value network architects (VNAs) or network attractors in ManyWorlds’ StrategySpace model.) Virtual companies can prosper when they have great influence within a non-egalitarian network and focus on autonomous innovation while continually developing their core competencies. As industries evolve and the form of innovation changes along with transaction costs, once-successful organizations become ill-fitting. This paper enriches our strategic understanding of fit business models for the ever-evolving innovation economy.