Open Innovation and Organizational Boundaries

19.
Open innovation and organizational boundaries:

task decomposition, knowledge distribution and
the locus of innovation
Karim R. Lakhani, Hila Lifshitz-Assaf and
Michael L. Tushman
This chapter contrasts traditional, organization-centered models of innovation with

more recent work on open innovation. These fundamentally different and inconsist-
ent innovation logics are associated with contrasting organizational boundaries and
organizational designs. We suggest that when critical tasks can be modularized and
when problem-solving knowledge is widely distributed and available, open innovation
complements traditional innovation logics. We induce these ideas from the literature
and with extended examples from Apple, the National Aeronautics and Astronomical
Agency (NASA) and LEGO. We suggest that task decomposition and problem-solving
knowledge distribution are not deterministic but are strategic choices. If dynamic
capabilities are associated with innovation streams, and if different innovation types are
rooted in contrasting innovation logics, there are important implications for firm
boundaries, design and identity.1
INTRODUCTION
Abernathy’s (1978) seminal empirical work on the automotive industry examined

the relations between a productive unit’s boundary (all manufacturing plants), its
organizational design (fluid versus specific), and its ability to execute product and/or
process innovation. Abernathy’s work and his associated ideas of dominant designs
and the locus of innovation have been central to scholars of innovation, research and
development (R&D) and strategy. Similarly, building on March and Simon’s (1958)
ideas of organizations as decision-making systems, Woodward (1965), Burns and
Stalker (1966), Lawrence and Lorsch (1967 [1986]) and Thompson (1967) explored
the relations between organization boundaries (business units), organization design
(differentiation and integration), and innovation in a set of industries that varied by
uncertainty. This early empirical work led to a wide range of scholarship investigating
the relations between a firm’s boundaries, its organizational design and its ability to
innovate.
In organizational economics, the notion of organizational boundaries has been rooted
in transaction cost logic. Economists favor an explanation based on minimizing transac-
tion costs (Coase 1937). Many activities related to innovation and the design and
production of goods and services are difficult to contract on the open market. These
transaction costs make it efficient for the emergence of firms and associated boundaries
that reduce
355
356 Handbook of economic organization
these costs by integrating these activities inside the firm (Williamson 1975, 1981). This
transaction cost tradition has clarified the relations between innovation and the logic
of differentiation between the firm and its surrounding environment (or market). This
literature has focused on understanding which set of activities should be inside or
outside the firm’s boundaries (e.g. Pfeffer & Salancik 1978 [2003]; Grandori 2001;
Santos & Eisenhardt 2005; Jacobides & Billinger 2006; Lavie et al. 2011). The primary
approaches employed by these traditions have been rooted in cost–benefit, knowledge
access or resource dependence analyses (e.g. Scott & Davis 2007).
Organization theory and strategy scholars have noted that core to value creation is the
production of complex goods and services requiring ongoing knowledge development
and transfer amongst diverse settings (March & Simon 1958; Chandler 1977; Grandori
2001; Nickerson & Zenger 2004). The burden of continuous knowledge creation
imposes high coordination costs that are best minimized through a managerial hierarchy
as opposed to a distributed approach in open markets (Thompson 1967; Tushman &
Nadler 1978; Kogut & Zander 1992; Nonaka & Takeuchi 1995). For anything but the
simplest problems, the visible hand of an organization’s management is required to
define and select problems that firms solve for value creation (Chandler 1990;
Nickerson and Zenger 2004). Finally, a significant body of research in organization
theory is rooted in setting a firm’s boundaries in a way that protects it from
dependencies in its task environment and puts boundaries around critical tasks, power
and competence contingencies (e.g. Thompson 1967; Pfeffer & Salancik 1978 [2003];
Aldrich 1979; Santos & Eisenhardt
2005).
However, users outside the firm are also an important source of functionally novel
innovations (von Hippel 1988, 2005). These users constitute self-organizing
communities that freely share knowledge (Baldwin & von Hippel 2011; Franke & Shah
2003; Faraj & Johnson 2011, O’Mahony & Lakhani 2011). The open source software
movement crys- tallized an alternative innovation ecosystem where external-to-the-firm
user communities design, develop, distribute and support complex products on their
own or in alliance with (or in some cases opposition to) incumbent firms (Lakhani &
von Hippel 2003; von Hippel 2005; Boudreau & Lakhani 2009; Lerner & Schankerman
2010; O’Mahony & Lakhani 2011). The rise and prevalence of community or peer
innovation, with its contrasting loci of innovation and non-hierarchical bases of
organizing, pose a challenge to the received theory of innovation, the firm and the firm’s
boundaries.
In this chapter, we attempt to reconcile these divergent scholarly perspectives on the
relationship between firm boundaries and the locus of innovation. We argue that the
innovation and organizational design literatures must move beyond debates between
open versus closed boundaries and instead embrace the notion of complex organiza-
tional boundaries where firms simultaneously pursue a range of boundary options
that include ‘closed’ vertical integration (e.g. Lawrence & Lorsch 1967 [1986]; Nadler
& Tushman 1997; Knott 2001), strategic alliances with key partners (e.g. Lavie &
Rosenkopf 2006; Rothaermel & Alexandre 2009), and ‘open’ 2 boundaries and open
innovation (e.g. von Hippel 2005; Chesbrough 2006). This simultaneous pursuit of
multiple types of organizational boundaries results in building organizations that can
attend to these complex, often internally inconsistent, innovation logics and associated
organization design requirements (O’Reilly & Tushman 2008; Boumgarden et al. 2012;
Gulati & Puranam 2009).
Open innovation and organizational boundaries 357
We suggest that two contingencies drive the degree to which a firm chooses along
this closed-to-open boundary continuum; the degree to which critical tasks can be
decomposed and the extent to which problem-solving knowledge for these tasks is
distributed. These task and knowledge contingencies are not deterministic; they involve
strategic choice by the firm and shift as the product life cycle evolves (Child 1972;
Grandori 2001; Foss et al. 2010; Foss, Chapter 4 in this volume). Choices about task
decomposition and knowledge distribution inform the choice of firm boundaries. The
ability to understand the nature of these critical task characteristics and, in turn, link
these choices to the firm’s boundaries may be an important dynamic managerial
capability (Helfat and Peteraf 2003). Further, because firms have several critical tasks
that differ along these decomposition/knowledge dimensions, the firm is likely to have
multiple boundary types.
We also suggest that open innovation may increasingly crowd out more traditional
intra-firm innovation. Such a shift in the locus of innovation has profound implications
for the design, boundaries, and identity of incumbent firms. Two secular trends in the
economy drive the increasing importance of open innovation. The first is the increasing
prevalence and importance of ‘digitization’ (Greenstein 2010), wherein information and
physical products are represented in the binary language of computers. While initially
confined to pure information products and software production, digitization is a trend
that now envelopes large parts of the economy. Importantly, material objects are under-
going transformations so that their ‘information shadow’ (Baldwin & Clark 2006), that
is, the information component of any material object, is now being represented as a
digital good. Thus material and physical objects can now be created, represented, modi-
fied and transformed with the same relative ease as software goods. An implication of
this digitization is the opportunity to apply the principles of task decomposition widely
used in the computer hardware and software industries (Baldwin & Clark 2000) to many
more parts of the economy.
The second and related trend is the increasing number of actors that can participate
in knowledge production at very low costs. Over the past three decades, the internet and
other advanced information and network technologies have democratized the tools of
knowledge creation. This trend has significantly eased the cost of knowledge dissemina-
tion, reduced communication and coordination costs, and made it easier to find and
access distributed knowledge from almost anywhere in the world (Benkler 2006;
Castells 2000; Shirky 2008).
Key to our understanding of the relations between organizational design, firm
boundaries and innovation is the ability of a firm and its leaders to engage in strategic
decomposition of underlying innovation tasks and understand the associated locus of
knowledge required to effectively deliver products. The strategic decomposition and
locus of knowledge perspective argues that the architecture of products is not fixed
either in the firm or in industries. Instead, executives (managers and technologists)
choose to partition and repartition the problem space such that they have the option to
access distributed knowledge above and beyond the traditional emphasis on intra-firm
technological development.
Strategic task decomposition enables organizations to access the distributed knowl-
edge of external individuals or communities without resorting to traditional means
of backwards or forwards integration. Task decomposition in the context of low-cost
communication has catalyzed the emergence of self-organizing communities that

are as effective as firms in innovation and knowledge production (O’Mahony &
Lakhani 2011). Thus previously firm-based innovation activities may now be done
on the outside in market or community settings (Boudreau & Lakhani 2009). 3 At the
same time, firms may decide to exit relationships with external or open sources of
innovation for a perceived propriety advantage associated with more integrated task
choices. We argue that a firm’s ability to ‘refactor’, or dynamically compose or
decompose critical tasks, is an important determinant of the firm’s boundaries and,
in turn, its ability to innovate.
Hand in hand with strategic decomposition is the recognition that the appropriate
knowledge required to solve innovation problems is both widely distributed (Hayek
1945) and sticky (von Hippel 1988). The widespread and general phenomenon of user-
based innovation is rooted in users having unique needs and solution information (von
Hippel 1988). Users exploit this knowledge to create novel innovations (Riggs & von
Hippel 1994). Thus the locus of innovation shifts to where knowledge may be the sticki-
est to transfer, often with users that are widely distributed in the economy. Users may
also form self-organizing collectives and communities where need and solution
information are rapidly discovered and transferred under a common free-revealing
paradigm (Fjeldstad et al. 2012; Franke & Shah 2003; Lakhani & von Hippel 2003;
Baldwin & von Hippel 2011).
With the democratization of the tools of both knowledge production and dissemina-
tion, a range of actors outside traditional firm boundaries have access to unique
solution knowledge that may be applicable to innovation tasks within firms
(Fjeldstad et al. 2012; Jeppesen & Lakhani 2010; Boudreau et al. 2011). Such task
decomposition and the fact that widely distributed actors have access to
differentiated knowledge push the locus of innovation outside traditional firm
boundaries. We suggest that task decomposition and knowledge distribution provide
a framework for the choice of firm boundaries. These strategic contingencies lead to
a different set of design and boundary choices than the traditional contingencies of
asset specificity, information processing or strategic ‘coreness’ (see also Grandori 2001;
Nickerson & Zenger 2004). Finally, we suggest that firm-centered innovation logic is
fundamentally different and inconsistent from open innovation logic, and that open
innovation logic is increasingly gaining momentum. If so, our theories of
innovation, organizational design and organizational change must capture the tensions
between these contrasting innovation modes.
Our chapter is organized as follows. First we analyze Apple and its ability to alter
(open and close) its boundaries across a range of activities, to build an empirical
ground- ing for our theoretical reconciliation. The next section outlines the extant
literature on firm boundaries and the locus of innovation. We then present drivers of
complex boundaries by illustrating the joint impact of strategic task decomposition and
distributed knowledge for incumbent firms as diverse as LEGO and NASA. The
following section induces a model of innovation and complex organizational
boundaries. We suggest several core contingencies associated with the firm’s
boundaries and discuss implications of organizing when firms must attend to multiple
and inconsistent innovation logics. Finally, we suggest implications of complex
organizational boundaries for the organization theory, strategy and innovation
literatures.
COMPLEX AND DYNAMIC BOUNDARIES AT APPLE
All computer manufacturers, such as Apple, Hewlett Packard (HP), Lenovo, and Dell,
address the following five distinct technical domains in order to produce and sell a com-
puter system: (1) hardware; (2) operating system; (3) standards (the main specifications
that allow for interoperability); (4) user experience (the user interface); and (5) applica-
tions. Figure 19.1 lays out how these domains have been addressed by PC
manufacturers by locating them in a matrix comprised of task decomposability and the
degree of knowledge distribution. For simplicity purposes we present a binary choice
for both axes, between high and low task decomposition; that is, modular and integrated
tasks (see also Nickerson & Zenger 2004) in the rows, and narrow and broad
knowledge distribution for the columns. This results in a range of boundary choices for
firms, from internal development, to complex intra-firm structures (e.g. ambidextrous
designs), to working with partners and/or consortia, to working with markets or
communities.
In Figure 19.1, the lower-left quadrant shows the traditional, internally driven
organizational model for innovation. Managers of the firm determine that the relative
task decomposition opportunities are low and requisite problem-solving knowledge is
all within the firm, resulting in internally developed innovation. The upper-left quad-
rant indicates that the firm managers have decomposed innovation tasks in a way that
enables external parties to contribute, however the knowledge required to accomplish
such tasks lies within a strategic partner. The lower-right quadrant indicates that while
task decomposition is low, the benefits of having several actors participating in the crea-
tion of innovations, via a consortium, are high enough that the incumbent firm absorbs
the added cost of integration. Finally, the upper-right quadrant indicates that the firm
has enabled task decomposition in a way that allows a range of actors to join in by
market or community-based approaches. The distinction between using a market or a
Partner Market
High Apple
Apps. Apps.
(Modular) User
Experience Dell, HP
Operating
System Community
Hardware
Task
Decomposition
Ambidextrous
design
User
Experience Standards
Operating Hardware
System (Apple, IBM,
Low Motorola‐
(Integrated) PowerPC)
Intra-Firm Consortia
Narrow
Problem Solving Broad
Knowledge
Distribution
Figure 19.1 Apple and the computer industry

community approach to innovation is grounded on the relative degree of social relations

and interdependence a firm has with the external parties. Markets rely mostly on formal
contracts and arm’s-length relationships with suppliers, while communities require the
firm to have employees actively participate in the innovation process (see for example
Rosenkopf et al. 2001; West & O’Mahony 2008).
An ambidextrous design (ie. intra-firm structural heterogeneity with structural link-
ages) is an appropriate design choice when there is strategic interdependence after tasks
have been decomposed and where there is knowledge heterogeneity either within the
firm or with the firm and external actors (O’Reilly & Tushman 2008; Rothaermel &
Alexandre 2009; Lavie et al. 2011). Ambidextrous designs build in boundary and
structural heterogeneity such that the firm can operate simultaneously in distinct
innovation modes.
Figure 19.1 shows that a typical personal computer (PC) firm in the 1990s chose a
strategy of problem decomposability across all technical domains. Most vendors had
chosen Intel and/or AMD as suppliers of the hardware microprocessor and had relied
on Microsoft Windows for the operating system and the user experience. These partner-
ships allowed PC manufacturers to work as integrators of the dominant technologies
developed by Intel and Microsoft. The supply of applications was left to an unregulated
market where any actor could create software and sell directly to users (see Morris &
Ferguson 1993). Standards for interoperability were developed through various insti-
tutes for electrical and electronic engineers (IEEE), internet engineering task force
(IETF) committees and other ad hoc organizations (for example the WiFi standard, the
TCP/IP standard and the USB standard).
In contrast, driven by Steve Jobs’s strategic point of view, Apple followed an inte-
grated and internal strategy for most of its PC stack (Isaacson 2011). In the late 1990s
the hardware used by Apple was built in close consortium between IBM and Motorola
and created a software operating system and user interface that was unique and different
from the Windows–Intel industry standard. No one had the rights to either use or
modify the integrated combination of Apple’s hardware, operating system and user
interface stack. Similar to the rest of the PC industry, applications were developed in an
unregulated market of developers. Figure 19.1 illustrates the contrast between Apple’s
primarily integrated internal development strategy and the practice of working on
decomposable tasks with partners in the rest of the computer industry.
However, by the late 1990s, Apple was in financial and technical trouble. The
Microsoft–Intel-based platform was significantly outperforming Apple systems in
technical and cost performance. Apple failed to update its operating system to modern
requirements and the financial press speculated that the firm was in its last throes. Apple
was on the losing side of a dominant design that comprised Intel-architecture hardware
and Microsoft-originated operating system, user interface and compatible applications
(Cusumano and Selby 1995).
Strategic Decomposition of the Operating System and Working with Communities
In the early to mid-1990s Apple began three independent attempts to update and mod-
ernize its computer operating systems. All three attempts failed due to lack of appropri-
ate programming talent and poor execution of the various projects. In 1996, Apple’s
executives decided that they did not have the internal capability to completely invent a
Partner Market
Self‐
High Organized
Apps.
(Modular) Community
Mobile
Hardware Task No
Community Longer
Hardware 2 Operating Pursued
System 1
Task
Decomposition
Ambidextrous
User design
Experience PC and
Operating Mobile
System Standards
Mobile 3 Hardware
Hardware
Low
(Integrated) Intra-Firm Consortia
Narrow Problem Solving Knowledge Broad

Distribution
Double arrow on line means tasks are
occurring in multiple loci
Figure 19.2 Dynamic boundaries at Apple
new operating system and recommended that the next version of the operating system
be obtained through an acquisition of NeXT Software (the company Steve Jobs founded
after he was ousted from Apple in 1985). Apple released the open source components of
its operating system as a separate software distribution called ‘Darwin’ in 2000.
The NeXT operating system itself was based on the Mach kernel, developed at
Carnegie Mellon University as a research project to further advance knowledge of oper-
ating systems, and on two open source software projects, FreeBSD and NetBSD, that
have had thousands of contributors participate in them. Apple thus took the fruits of the
open source community and leveraged it for its own next-generation operating system,
released in 1999: OS X. Figure 19.2(1) illustrates the integration of the open source
community in Apple’s proprietary process. The OS X operating system now powers
all Apple products including personal computers and mobile devices. Note that Apple
did not abandon its own operating system development efforts. Rather, some of the
modules of the software were now developed in concert with the community, and some
internally.
Apple acknowledges the importance of open source communities in this core aspect
of its product:
As the first major computer company to make Open Source development a key part of its
ongoing software strategy, Apple remains committed to the Open Source development model.
Major components of Mac OS X, including the UNIX core, are made available under Apple’s
Open Source license, allowing developers and students to view source code, learn from it and
submit suggestions and modifications. In addition, Apple uses software created by the Open
Source community, such as the HTML rendering engine for Safari, and returns its enhance-
ments to the community.
Apple believes that using Open Source methodology makes Mac OS X a more robust,
secure operating system, as its core components have been subjected to the crucible of peer
review for
decades. Any problems found with this software can be immediately identified and fixed by
Apple and the Open Source community.4
An analysis of Apple’s use of open source within the OS X system reveals that over
500 distinct components of the operating system use open source components from over
180 projects. Thus while the popular perception of Apple is as the paragon of propri-
etary and closed software development, its involvement in and use of open source
reveals a more nuanced approach that leverages the distributed knowledge of external
open source communities to its strategic advantage.
At the same time, while open source works within the core of the operating system,
the key elements of the user interface and the user interaction model are proprietary
and remain under Apple’s strict purview and oversight. Indeed the Darwin operating
system cannot run most of the Macintosh OS X applications as it does not have access
to Apple’s proprietary graphical user interface, rendering libraries, or engine. Thus,
Apple has been able to separate the technical problems that are core to its success (but
invisible to its users) and has pursued an open boundary approach in that area. In sharp
contrast, in areas that require direct consumer interaction that differentiates Apple from
Microsoft, Apple made proprietary and closed investments in technologies and designs
that it does not make available to anyone else.
Apple’s decomposition of the operating system enables it to simultaneously use open
and closed boundaries for its strategic tasks. This attention to strategic boundary man-
agement has enabled Apple to release a new version of the operating system every one
to two years. The use of open boundaries has a significant cost advantage, as a large
portion of Apple’s operating system software is developed externally to the firm by
others.
Simultaneous Decomposition and Reintegration
Apple’s actions around the computer processor for its various products indicate a
sophisticated understanding of managing firm boundaries to meet strategic objectives.
Up to 2005, Apple had relied on the PowerPC chip architecture for microprocessors
within its computer line. The PowerPC alliance was a joint technology venture between
IBM, Apple and Motorola to create chips that would compete against Intel processors
for a range of computer applications. In effect Apple and its partners were in the custom
chip design business against a competitor that had orders of magnitude more volume.
In the early 2000s, Apple discovered that its PowerPC partnership was not keeping
up with the technological requirements needed to stay competitive. This prompted the
firm to exit the PowerPC consortium and enter into a special partnership with Intel to
incorporate its standard chip design into Apple’s computing platform. In this case Apple
devolved the advantages of vertical integration for the benefits of working within the
framework of Intel’s dominant design. Apple customers were not purchasing its prod-
ucts for its microprocessor, but instead wanted access to the proprietary Apple operat-
ing system and user interface. As long as the chips by Intel kept up with the standards
in computing there was no strategic reason for Apple to be engaged in activities in chip
design and manufacturing. Hence Apple decomposed the innovation tasks related to
hardware to an external partner (Figure 19.2(2)).5
In contrast, in mobile devices, Apple decided to reject the prevalent dominant chip
design of the mobile-ARM architecture and instead invested in acquiring several firms
that enabled Apple to design its own custom chips. In this case the logic of following
the dominant design via decomposition is reversed. In Apple’s assessment, the techni-
cal performance criteria for mobile chips are strategically core. As such, there was a
strategic logic to have a proprietary approach that minimizes power consumption and
maximizes speed and responsiveness customized to its own device. Apple’s assessment
of the technological frontier in mobile chips was that adopting the dominant design
would not provide strategic benefits to the firm. Adopting this standard would instead
allow its competitors to achieve similar performance outputs and claim parity in
performance in mobile devices. All of the recent Apple mobile computing devices now
have this custom chip technology (Figure 19.2(3)).
The simultaneous acceptance of dominant design in microprocessors for computers
and the rejection of the dominant design for mobile applications illustrate the linkages
between choices of task decomposition and the firm’s boundary. These examples also
illustrate that adoption of a dominant design is contingent on a firm’s strategy and the
shifting basis of competition. Apple’s ability to alter its boundaries at these critical junc-
tures illustrates that the locus of innovation shifts are based not just on a cost minimiza-
tion logic, but also on access to knowledge that provides competitive advantage.
Figure 19.2 provides a full accounting of Apple’s current stage of boundaries in the
various aspects of its business. The figure shows that Apple has been able to
continuously shift boundaries to suit strategic, technical and competitive needs. These
innovation patterns have the quality of shifting firm boundaries from integrated, intra-
firm boundaries to ever more complex intra- and extra-firm boundaries. These set of
firm boundaries include intra-firm differentiation, external partners and consortia, as
well as leveraging open innovation. These boundary choices are associated with
strategic decisions as to whether the product is decomposable or is inherently integrated
(at a point in time) as well as the locus of solution knowledge. Apple keeps integrated
components within its control and hierarchy, while it has explored more complex
boundary relations for components that can be decomposed and whose solution
knowledge is widely distributed.
Note that Apple employed these complex and dynamic boundaries in the context of
performance crises associated with its prior more simple approach to boundary manage-
ment. These organizational shifts were, in turn, associated with the transformation of
Apple as a firm. Such complex sets of boundary types and boundary relations triggered
significant identity, governance, intellectual property (IP) and associated leadership
issues within Apple (Isaacson 2011). In particular, Apple’s organizational design
evolved such that it could simultaneously attend to the complex challenge of holding
some innovation within the firm’s control while other innovation was executed with
communities of actors outside Apple and, in the extreme, with anonymous contributors.
INNOVATION AND FIRM BOUNDARIES: THE CONTROL OF

CRITICAL CONTINGENCIES
Since Schumpeter (1947), Barnard (1938 [1968]), Chandler (1962) and Myers and
Marquis (1969), scholars have emphasized innovation as a source of a firm’s competi-
tive advantage. Much of the early innovation work was rooted in R&D investments, the
building of internal R&D capabilities, and the associated specialized assets associated
with the invention, patenting and execution of portfolios of innovations (e.g. Allen
1977; Cohen & Levinthal 1990; Clark & Fujimoto 1991; Dougherty & Heller 1994;
Fleming 2001; Dougherty & Dunne 2011).
There is extensive literature on designing organizations to create streams of inno-
vations (e.g. O’Reilly & Tushman 2008). In a world of uncertainty and asset-specific
investments, transaction costs logic argues that firms with tight boundaries outperform
markets in the production of innovative outcomes (e.g. Williamson 1975, 1981; Knott
2001). Similarly, the knowledge-based view of the firm suggests that when products or
services are complex and non-decomposable, the firm outperforms market mechanisms
(e.g. Kogut & Zander 1996; Grandori 2001; Nickerson & Zenger 2004). In such ‘M’- or
‘U’-form firms, authority is vested with senior leaders who create structures, processes,
capabilities, cultures and information processing capabilities such that firms gain the
benefits of specialization as well as integration (e.g. Tushman & Nadler 1978; Nonaka
& Takeuchi 1995).
In a similar spirit, the resource dependency literature is rooted in a logic where
the boundaries of the firm are established to maximize the control of critical contin-
gencies. For those contingencies that are not internalized, the firm acts to minimize
dependence on, gain control of, co-opt or negotiate with critical external actors
(Pfeffer & Salancik 1978 [2003]; Davis & Greve 1997; Aldrich 2008). This design
literature with its firm focus and efficiency logic is associated with specifying the
firm’s formal boundaries as well as its power, competencies and identity boundaries
(Santos & Eisenhardt 2005).
Strategic contingencies shift over time. Research on the sociology of innovation
and technical change suggests that new markets open with a burst of technical vari-
ants competing for dominance. This era of technical ferment ends with the closing of
industry standards or dominant designs (e.g. Abernathy & Utterback 1978; Tushman &
Rosenkopf 1992; Rao 1994) For example the automobile engine (Abernathy 1978; Rao
1994), power system (Hughes 1983), watch (Landes 1983), chemical and dye
(Murmann 2003), disk drive (Christensen 1997) and flight simulator (Rosenkopf et al.
2001) industries were initiated by periods of technological variability. During these
eras of ferment, integrated products compete for both technical and market dominance
(Anderson & Tushman 1990). Such periods of uncertainty are closed as dominant
designs emerge by either competitive selection, coalition or law (see Suarez 2004;
Murmann & Frenken 2006).
Once a dominant design emerges, the nature of innovation shifts to the product’s
components, process innovation becomes more intense and innovation becomes more
incremental (see Rao 1994; Rosenkopf & Tushman 1998; Murmann 2003). Eras of
incremental change are associated with a shake-out in the product class and increases
in the size and scale of those firms associated with the industry standard (e.g. Jenkins
& Chandler 1975; Wise 1985; Anderson & Tushman 2001). These eras of incremental
change, in turn, are disrupted by subsequent technological discontinuities which trigger
a subsequent technological cycle (Tushman & Anderson 1986; Tushman & Murmann
1998). There are profound task, organizational, and boundary implications to these
technology cycles. During eras of ferment, integrated firms with organic structures are
better at exploration; while during eras of incremental change, more mechanistic struc-
tures are better at exploiting a given technical trajectory (e.g. Abernathy 1978;
Lawrence & Lorsch 1967 [1986]; March 1991).
At these transitions, when firms shift from integrated innovation to modular or
decomposed innovation, firms also shift to more intense process innovation and grow
in scale. These punctuated changes are associated with higher levels of both boundary
differentiation as well as more extensive structural and cultural integration (e.g. Van
de Ven et al. 1989; Schoohoven et al. 1990; Romanelli & Tushman 1994). Finally, for
incumbents that survive these dynamics, the next wave of variation, selection and reten-
tion is executed through a range of boundary-expanding mechanisms including ambi-
dextrous structures, alliances or joint ventures (e.g. Gulati 1995; Lavie & Rosenkopf
2006; Tushman et al. 2010).
The literature on managing innovation streams has a focal firm as its unit of analysis
(or in some cases the product class) and has built an extensive literature on the architec-
tures, structures, cultures, linking mechanisms, alliances and governance modes associ-
ated with firms that can exploit as well as explore within the firm as well as with
selected partners (e.g. Lavie & Rosenkopf 2006; Helfat et al. 2007; O’Reilly &
Tushman 2008; Boumgarden et al. 2012; Agarwal & Helfat 2009). Such complicated
designs to execute innovation streams are also associated with distinctive identities that
permit contradictory architectures and their associated complex boundaries to coexist
(Gioa et al. 2000). This innovation and organization design literature has a logic
where the focal firm internalizes those innovation components that are core to its
strategy even as it builds complex boundaries and internally contradictory architectures
to explore and exploit. For example, Ciba Vision extended its innovation beyond
incremental innovation in conventional lenses (within Ciba Vision’s extant
organization) to include daily- disposable and extended-wear lenses (via an
ambidextrous design), as well as developing an age-related macular degeneration
product (executed in collaboration with an Australian partner). These set of
complex structures and associated boundaries were managed by the senior team
anchored with Ciba Vision’s identity as a firm dedicated to ‘healthy eyes for life’
(Tushman et al. 2010). The driving impulse in this literature on innovation and
organization boundaries and design has been the control or buffering of
the firm’s context through complex boundary selection and management.
Innovation and Open Boundaries: The Firm in the Context of Distributed Innovation
In contexts where computational costs are low and widely available and where dis-
tributed communication is inexpensive, open or peer innovation communities displace
organization-based innovation (Baldwin & von Hippel 2011). In these contexts,
communities of peers spontaneously emerge to freely share information on innovation
production as well as problem solving. Such radically decentralized, cooperative, self-
organizing modes of problem solving and production are in sharp contrast to
organizationally centered innovation (Lakhani and von Hippel 2003; von Hippel 2005;
von Hippel and von Krogh 2003; Murray and O’Mahony 2007)
Open innovation is most clearly seen in open source software development. Open
source software development depends on many individuals contributing their time, for
free, to a common project. Legally, participants retain copyrights for their contributions
but then license them to anyone at no cost (see Benkler 2006; Lerner & Schankerman
2010 for more detail). These self-organized communities develop their own emergent
social structure (e.g. O’Mahony and Ferraro 2007; Fleming and Waguespack 2007).
Such communities of developers rely on the availability of easy communication, the
modularity of the project and intrinsic motivation. This open software innovation
regime creates robust products and is equivalent to private market software development
methods in features, functionality and quality (Raymond 1999; Benkler 2006; Lerner &
Schankerman 2010).
Community-based innovation is not limited to software development. Peer modes of
innovation, where actors freely share and co-create innovation, have been documented
in a range of product domains. For example, von Hippel and his colleagues have docu-
mented user and peer innovation in heart–lung machines, gas chromatography, moun-
tain bikes and in many other products (Franke & Shah 2003; von Hippel 2005). In each
of these examples, user communities spontaneously emerge to create new markets.
Once the product is developed, only then do incumbents enter and shift the nature of
innovation to cost and scale.
While communities are associated with the creation of new markets and the adjudica-
tion of uncertainty during the associated eras of ferment, autonomous problem solving
also occurs through prize and contest-based mechanisms that allow for free entry but
emphasize competition amongst peers. Perhaps the most famous early example of inno-
vation contests is the British government’s contest to find a way to accurately gauge
longitude at sea (Sobel 1995). While contests are associated with prizes, the prizes are
often relatively small and most problem solvers do not win. Yet analyses of these
tournament settings reveal large-scale entry into tournaments, far above predictions
from an economics perspective (Che & Gale 2003; Boudreau et al. 2011). This
extensive external participation indicates the presence of complex intrinsic and
extrinsic motivations (Boudreau and Lakhani 2009; Jeppesen and Lakhani 2010;
Boudreau et al. 2011).
Both community- and contest-based problem solvers are motivated by a heterogene-
ous blend of intrinsic and extrinsic motivations and the emergent social properties of
interactions in online settings (Lakhani & Wolf 2005; Fleming & Waguespack 2007;
Gulley & Lakhani 2010; Boudreau et al. 2011). When the problems are modular in
nature, these communities have had dramatic impact on problem solving outcomes (see
Kogut & Metiu 2001; Lakhani & von Hippel 2003). These anonymous communities are
self-motivated, self-selected and self-governed (von Krogh et al. 2003; Boudreau et al.
2011; Dahlander & Gann 2010). In these anonymous contexts, self-selection drives both
participation and effort (von Krogh et al. 2003; Boudreau & Lakhani 2009).
The availability of inexpensive computation power and ease of communication
permits a fundamentally different form of innovation; a mode of innovation that is
rooted in sharing and openness free of formal boundaries and formal hierarchy. If so,
these non-market, peer innovation methods promise to complement, and under some
conditions displace, firm-centered innovation models (e.g. Wikipedia’s substitution for
Microsoft Encarta and the Encyclopedia Britannica). For incumbent firms, community-
based innovation modes stand in sharp contrast to their historically anchored organiza-
tionally based innovation mode.
To the extent that market and non-market innovation modes are complements, firms
build multiple and contrasting innovation regimes in service of innovation streams
(O’Reilly & Tushman 2008; Boumgarden et al. 2012; von Hippel & von Krogh 2003).
Such paradoxical, internally inconsistent innovation modes require, in turn, organi-

zational designs, complex boundaries and senior team attention to such contrasting
requirements (Smith & Lewis 2011; Andriopoulos & Lewis 2009). In contrast, if these
distributed communities dominate incumbents at new-product creation and are effective
in modular problem solving, these communities will displace the traditional firm in key
domains of the innovation system.
Solution Generation and Selection Knowledge and Locus of Innovation
Under what conditions do these various innovation modes dominate? King & Lakhani
(2012) develop a framework to reconcile the coexistence of various modes of organiz-
ing innovation from internal development to markets using voting, approval contests,
prizes and tournaments, and to communities. Building on Campbell’s (1969) evolu-
tionary concepts, they argue that the central tasks in organizing for innovation are
two knowledge-based activities: (1) generating a range of solutions to an innovation
problem; and (2) selecting the appropriate solution(s) from the myriad of alternatives
available (Terwiesch & Ulrich 2009).
Based on this variation and selection approach to innovation (see also Vincenti
1994; Murmann & Frenken 2006), King & Lakhani (2011) develop a knowledge-based
approach to the locus of innovation (see also Nickerson & Zenger 2004; Grandori
2001). If the knowledge needed to accomplish either knowledge generation or selection
is narrowly held in the firm, the associated innovation boundaries will be
fundamentally different than when knowledge is more widely distributed amongst
multiple external actors and disciplines. The more either solution generation or selection
knowledge is broadly held, the greater use of open boundaries. In contrast, to the extent
that either solution or selection knowledge is narrowly concentrated in the firm, the
more internal boundaries dominate (see Figure 19.3).6
As tasks become more modular (or decomposable) and as solution and use knowl-
edge is more widely distributed, the locus of innovation shifts to open communities. If
so, the nature of the incumbent’s identity, its structures, associated boundaries, culture
and incentives cannot be rooted in theory and research anchored on cost, control and
extrinsic incentive premises. An innovation model based on traditional firm and more
open assumptions requires a theory of when and under what conditions different types
of boundaries are associated with innovative outcomes. Further, if dynamic capabilities
are rooted in multiple types of innovation executed simultaneously, we must build a
theory of the firm that can handle complex boundaries, organizational designs and
associated complex identities (see also Pratt & Foreman 2000; Santos & Eisenhardt
2005; Murray & O’Mahony 2007).
DRIVERS OF DYNAMIC BOUNDARIES IN INCUMBENT

FIRMS
Core to our perspective on the locus of innovation and complex organizational bounda-
ries is the ability of senior executives to engage in strategic task decomposition (or
reintegration) based on their firm’s shifting competitive context. The Apple example
provided
Broad
External Voting and Community

Approval Contests
Selection
Knowledge
Internal Firm Effort Knowledge Markets: Tournaments

and Prizes
Narrow
Narrow
Solution Broad
Generation
Knowledge
Figure 19.3 Generation and selection knowledge and locus of innovation
an illustration of a firm taking advantage of the advances in task modularity in its indus-
try and, in turn, accessing distributed knowledge by opening (and closing) its
boundaries to external actors. Building on our Apple example, we examine the response
of LEGO to community toy development and NASA’s space life sciences laboratory to
open innovation. We use these examples to induce a contingent model of complex
organizational boundaries, locus of innovation and innovation outcomes.
LEGO
LEGO Group’s experience with complex boundaries illustrates how an organization

stumbled into the advantages of decomposition and distributed knowledge and then
learned to effectively use this capability for subsequent innovation efforts. Founded in
1932 to make toys for children, the firm’s main product line since 1949 has been plastic
‘bricks’ that enable creative play and ignite imagination amongst children around the
world. The bricks business at LEGO has been traditionally organized with the firm
having core competence in both the manufacturing process (extremely high-tolerance
plastic injection moldings) and the creation of various themes and scenes that are sold as
pre-packaged playsets.
As extensively documented by Antorini (2007), LEGO, initially unbeknownst to the
company and outside of its control, attracted legions of adult fans, the so-called Adult
Fans of LEGO (AFOL). These engaged users self-organized into various online
communities and shared knowledge on creative designs and use of bricks for a set of
complicated projects. These communities of passionate fans not only wrapped their
personal identity around AFOL, but also innovated in the classic user innovation sense
by modifying and
Market
Partner
3 Self‐
2
High Organized
(Modular) Community
NXT Software NXT Software Community
NXT NXT
Components Components
Themes & Themes &

Scenes Scenes
LEGO
Brick Design Brick Design Sponsored
Task NXT Software Community
Decomposition NXT
Ambidextrous 4 1
Components
design
Themes &
Scenes
Low Brick Design
(Integrated)
Consortia
Intra‐Firm
Narrow Problem Solving Knowledge

Distribution Broad
Figure 19.4 Dynamic boundaries at LEGO
extending the original bricks, inventing new bricks and developing new designs (e.g.
von Hippel 1988). The community went as far as creating an online software tool kit
where both designs for new bricks as well as new LEGO inspired creations were
modeled and shared. Built just like an open source community, the AFOL members
openly shared designs, tools and techniques to collectively enhance their experience
with LEGO bricks (see Figure 19.4(1)). LEGO executives initially considered these user
communities a minor ‘shadow market’ and did not engage with them in a meaningful
manner (Hatch & Schultz 2010).
In 1998 Lego released a brick-based robotics kit called LEGO Mindstorms aimed
primarily at children. The kit, with its 727 parts, enabled children to create and program
robots that could perform various tasks. However, within weeks of the release of the
Mindstorms kit, adult enthusiasts discovered that these kits also served their intel-
lectual curiosity about robots. One of them, a Stanford University graduate student,
Kekoa Proudfoot, within months of the release, reverse engineered the kit and released
to the internet all his detailed findings including the underlying software for the robot’s
operations.
The software release led to a burgeoning online community that created their own
Mindstorm programming kits. These kits included the creation of custom and more
user-friendly software language and an open source operating system to operate the
Mindstorms bricks (LegOS). Soon there were more engineers and software developers
working on Mindstorm development outside the firm than within it.
Within LEGO there were divergent opinions about how to deal with external com-
munities innovating, without permission, on their products. As described by Koerner
(2006):
Lego’s Danish brain trust soon realized that their proprietary code was loose on the Internet
and debated how best to handle the hackers. ‘We have a pretty eager legal team, and protecting
our IP is very high on its agenda,’ Nipper says. Some Lego executives worried that the hackers
might cannibalize the market for future Mindstorms accessories or confuse potential customers
looking for authorized Lego products. After a few months of wait-and-see, Lego concluded
that limiting creativity was contrary to its mission of encouraging exploration and ingenuity.
Besides, the hackers were providing a valuable service. ‘We came to understand that this is a
great way to make the product more exciting,’ Nipper says. ‘It’s a totally different business
paradigm – although they don’t get paid for it, they enhance the experience you can have with
the basic Mindstorms set.
LEGO’s decision to allow community innovation to flourish resulted in the establish-

ment of dozens of websites devoted to sharing third-party robotics programs that built
systems such as soda machines and blackjack dealers, and the creation of new sensor
and capabilities that were well beyond the original kit. Over 40 guidebooks were written
to help users extend the capability of the Mindstorms kits. Just like the AFOL, LEGO
executives followed a benign neglect strategy with these communities, allowing them to
exist but not impacting their own internal direction (see Figure 19.4(2)).
In 2004, LEGO realized that its external community had done more to add value
to LEGO than its own internal efforts and decided to formally integrate key external
contributors for the release of Mindstorms NXT (Koerner 2006). Initially limited to
four community members with expertise in sensors and software, the Mindstorms User
Panel (MUP) closely collaborated with LEGO R&D to improve the next release of
the product. The MUP members provided rapid feedback on a range of technical and
market issues and further suggested new features and configuration that would make the
user experience standout:
Once the MUPers signed on, they sent numerous suggestions to Lund (the LEGO Manager
responsible for NXT) and his team. The executives responded with appeals for feedback on
planned improvements. ‘We would ask them about a planned feature,’ Lund says, ‘and within
half an hour, there would be a four-page email on it.’ The Lego team was eager to piggyback
on the work MUP members had already done.
LEGO then decided to further increase the number of MUP members to over 100 par-
ticipants and credits their involvement with the successful launch of the NXT program
(Hatch and Schultz 2010), see Figure 19.4(3).
While LEGO was pushed into supporting community-based innovation with the
Mindstorms experience, the firm has now embraced this open innovation mode through-
out its customer-facing operations. LEGO has established an ambassadors program that
selects 75 individuals from its user communities to work hand in hand with LEGO staff
on a range of innovation and product development issues. LEGO is also experimenting
with having users showcase their custom designs and then create an ability to sell them
to other interested users (see Figure 19.4(4)). More generally, LEGO has integrated
communities inside its major product lines so that users can showcase their talents and
creations. These activities are now part of LEGO’s new business unit, Community,
Education and Direct (CED), which contributes 15 percent of revenues and is growing
twice as fast as the larger LEGO Group (Hatch and Schulz 2010).
This shift to these more complex boundaries at LEGO, managing innovation through
internal as well as open mechanisms, was not easy to execute. These shifts in
managing innovation were only executed under crisis conditions and under a new,
externally recruited leadership team. This new senior team transformed LEGO by
broadening its innovation mechanisms to include complex intra-firm structures as well as
open innovation. This use of complex organizational boundaries in service of innovation
streams was coupled, in turn, with transformational organization changes in LEGO’s vision,
identity, culture, structures and competencies (Hatch & Schultz 2010).
NASA – Space Life Sciences
On the surface, space sciences represent the ultimate in completely vertically integrated
programs where all elements are done internally. NASA has had the monopoly on civil-
ian United States (US) space travel for the past more than 50 years. Historically the
space agency has worked in close connection with select and elite aerospace and
defense contractors for the joint development of space vehicles and programs. NASA
contractors are closely integrated into its innovation and decision-making activities.
Since 2008, NASA’s Space Life Science Directorate (SLSD) has launched a series of
pilot projects to examine whether community and contest-based models of innovation
development might feasibly be applied to a variety of technical challenges that have tra-
ditionally been managed internally or with traditional suppliers. Central to this approach
has been significant effort by SLSD innovation management to determine which tasks
are amenable for broadcast search and possible solution generation by external provid-
ers. SLSD staff decomposed previously integrated problems into challenges that could
be put out to the rest of the world for solving.
During 2009–10, SLSD initiated three pilot projects with leading open innova-
tion platforms (InnoCentive, TopCoder, Yet2.com) to connect NASA problems with
worldwide problem-solving communities. Worldwide engagement in solving NASA’s
problems was extremely high. The seven problems posted on InnoCentive engaged over
2900 problem solvers from 80 countries and yielded solutions from 347 individuals. On
average each problem had 49 independent solution submissions. Previously intractable
innovation issues such as forecasting of solar events, improved food barrier layers, and
compact aerobic resistive device designs were rapidly resolved in communities.
NASA’s experience with the forecasting of the solar events indicates how open
innovation can substitute for traditionally firm-based innovation approaches.
Unexpected solar flares wreak havoc on space equipment and are dangerous to the
health of astronauts in orbit. Since the start of the space program, NASA has invested
significant financial and intellectual resources towards the development of better flare
forecasts. After years of investment, the best algorithms achieved a 55 percent
prediction accuracy, slightly better than tossing a coin. NASA decided that this
challenge would be suitable for contest-based problem solving. Working with
InnoCentive, NASA engineers developed a problem statement that sufficiently
described the required innovation in a way that transformed the problem from one of
helio-physics to a general computational development. The challenge was posted on
InnoCentive and had a reward amount of $30 000. In a three-month time period over
500 individuals expressed interest in trying to solve the problem by downloading the
problem statement and signing the solver agreement. At the close of the contest 11
individuals submitted solutions. The winning solution
Market
Partner
Prize
High Space Platforms
(Modular) Vehicle Design
Operations
& Mfg.
Life
Sciences
Community
Task
Decomposition
Ambidextrous
design
Space
Operations
Life
Sciences
Advanced
Low Exploration
(Integrated)
Intra Firm Consortia
Narrow
Problem Solving Knowledge Broad
Distribution
Figure 19.5 Dynamic boundaries at NASA
came from a retired telecommunications engineer. Using only ground-based equipment

instead of the traditional use of orbiting spacecraft, this algorithm improved forecasting
accuracy to 85 percent.
The extraordinary results of the pilot program prompted NASA to build out a gen-
eralized capability of decomposing tasks from various parts of space operations and to
consider using external innovation communities as a routine part of its research and
development efforts. In this case, contrary to Apple and LEGO, NASA did not build out
its own community of external solvers. Instead NASA chose to leverage the investment
of existing commercial platforms that have amassed via the internet hundreds of thou-
sands of individuals who have an interest in solving scientific and technical problems
(see Figure 19.5). However, similarly to Apple and LEGO, NASA’s shift to more
dynamic innovation boundaries was initiated under performance pressures and was
accompanied by changes in NASA’s culture, capabilities, structure and identity as it
attempted to manage internal and open innovation modes simultaneously.
OPEN INNOVATION AND COMPLEX ORGANIZATIONAL

BOUNDARIES
In settings where a product’s core tasks can be modularized and where the costs of com-
munication are low, traditional modes of organizing for innovation may not be com-
paratively effective or efficient. Under these ubiquitous conditions, open innovation, as
exemplified by communities and contests, transforms the economics and social
organization of innovation activities. Traditional organizing models based on cost
minimization,
Alliances Market
NASA: Open Innovation Contests

High
(Modular) PC Hardware Alliance
Automative Supplier Alliances
NASA: Vehicle Design & Manufacturing Community

Apple: Open Source OS
LEGO: AFOL & NXT Hackers,
LEGO MUPS & Ambassadors
Task
Decomposition
Apple: OS, UI, Mobile Hardware Ambidex trous Design
LEGO: Brick Design, Themes & Scenes,

NXT S/W
Apple: PC & Mobile Standards
Low
NASA: Life Sciences, Space Operations,
(Integrated) IBM: Semiconductor Manufacturing
Advanced Exploration
Consortium
Internal Firm Effort Networks
Narrow Problem Solving Knowledge

Distribution Broad
Figure 19.6 Task Decomposition, Problem Solving Knowledge Distribution, and Locus
of Innovation
power, control of contingencies and extrinsic motivation, and where the locus of
innovation is either within the firm or with the firm and trusted partners, must be
supplemented with organizing models rooted in logics of openness, sharing, intrinsic
motivation, and communities.
What are the contingent variables that push innovation from more traditional closed
and hierarchical modes to more open and distributed modes? We suggest that the funda-
mental contingent variables in selecting innovation modes and associated boundaries are
the extent to which the product is integrated in nature and the extent to which problem-
solving knowledge is distributed (see Figure 19.6). When core tasks are integrated in
nature (e.g. Apple’s consumer experience, NASA’s advanced exploration or LEGO’s
plastic brick toys) and problem-solving knowledge is concentrated, traditional intra-firm
innovation logic applies (see also Nickerson & Zenger 2004). Under these conditions,
firms internalize R&D and build an innovative culture, capabilities, absorptive capaci-
ties and processes that locate solution search and evaluation within the firm. These
intra- firm boundaries vary from simple functional boundaries to more complex
ambidextrous designs.
However, if problem-solving knowledge for an integrated product or service is
broadly available and distributed, firms may choose to participate in networks where co-
creation with external partners becomes a feasible alternative. The development of
technology standards is a canonical example; however, firms also employ consortia and
other forms of networks to drive innovation (IBM’s semiconductor manufacturing
consortium provides a vivid illustration; King et al. 2011). Similarly, increasing
modularity via task
decomposition, without the requisite expansion of knowledge distribution, leads firms

to develop alliances with limited other organizations that can fulfill specialized tasks.
PC hardware alliances between system integrators and Intel and AMD are the most
common examples. A similar logic drove Apple’s embrace of Intel. More generally,
firm- driven alliances emerge when task decomposition increases (the automobile
industry is another example).
In sharp contrast, when the product can be decomposed (or modularized) and when
problem-solving knowledge is broadly dispersed, the locus of innovation shifts outside
the firm. Such a shift in innovation locus requires incumbent firms to engage with exter-
nal communities in open, transparent, collaborative relations (for example, NASA’s
relations with external problem solvers; LEGO’s relations with its involved users; and
Apple’s relations with applications suppliers and anonymous operating system collabo-
rators). When costs of collaboration are low, the greater the task’s modularity and the
greater the knowledge dispersion, the more open innovation and its associated complex
organizational boundaries displace intra-firm innovation.
These shifts from closed to open innovation are associated with organizational trans-
formations as they involve integrated changes in the firm’s structure, boundaries, com-
petencies, culture and identity. As seen at NASA, Apple and LEGO, these punctuated
changes occur under crisis conditions and are typically initiated by top teams. Further,
these boundaries shift over time as tasks become more or less strategic. At Apple, for
example, its shift in mobile processors from open to closed innovation reflected its judg-
ment about the strategic value of integrated mobile chips. Finally, firms are made up
of portfolios of innovation types. For example, LEGO makes traditional plastic blocks
even as it makes Mindstorm robots; NASA innovates internally on advanced explora-
tion projects even as it employs open innovation on a range of modular tasks; and Apple
innovates internally on customer experience even as it innovates with communities in
applications and its operating system. The more complex the firm’s innovation streams,
the more complex its set of innovation logics, the more complicated and internally
inconsistent its organizational architecture and associated set of boundaries.
The organization design issues associated with the combination of open and closed
innovation modes are substantial because these innovation modes are themselves rooted
in fundamentally inconsistent organizing logics and because they go against the inertia
of the incumbent’s history. As seen at LEGO, NASA and Apple, such complex innova-
tion streams involve complex and heterogeneous identities, complex boundaries and
boundary-spanning capabilities, and complex governance modes (e.g. see also Fleming
& Waguespack 2007; O’Mahony & Bechky 2008). Firms must build on the capacity to
attend to paradox and contradiction as open and closed innovation logics are based on
contrasting organizing assumptions. The more complex the set of boundaries spanned,
the greater the importance of a firm’s absorptive capacity (Cohen & Levinthal 1990).
But where absorptive capacity has been traditionally related to R&D spending and its
associated enhanced combinative capabilities (e.g. Kogut & Zander 1992; Rothaermel
& Alexandre 2009), in an open innovation context, absorptive capacity includes both
combinative as well as collaborative capabilities (e.g. Rosenkopf et al. 2001; King &
Lakhani 2011).
Finally, if open and closed innovation modes are complementary yet internally
inconsistent, the firm’s senior team must attend to and deal with both innovation logics.
Agency associated with innovation streams and the associated complex organizational
boundaries is rooted in strategic choices of task integration (or decomposition) as well
as the leaders’ diagnosis of knowledge distribution (Nickerson and Zenger 2004;
Jeppesen and Lakhani 2010; King and Lakhani 2012). Thus our Apple example
illustrates strategic choice in both task decomposition in operating systems as well as
task integration for mobile hardware and user interface. Once complex innovation
modes are chosen, the associated organizational architectures and boundaries are
executed in settings that can handle the identity and innovation logic conflicts and
punctuated changes associated with operating in open and closed innovation modes
simultaneously (e.g. Gioia et al. 2000; Smith & Tushman 2005; Kaplan & Tripsas
2008).
While open and closed innovation modes may be complementary, when might they
be substitutes? As products and services become more modularized and as
communication costs drop such that dispersed knowledge is widely available, open
innovation communities emerge that increasingly displace closed innovation (Benkler
2006; Baldwin & von Hippel 2011; O’Mahony & Lakhani 2011). Under these
increasingly common conditions, open innovation does not complement firm-based
innovation, but rather is a substitute (e.g. EMI’s inability to deal with new forms of
music generation, funding, production and distribution). If so, incumbents may be
pushed out of generating anything but incremental and/or process innovation (von
Hippel 2005). It may be that new entrants dominate incumbents in new product creation
by relying on community innovation for all substantive innovation except for
innovation in customer experience and/or product integration. For example, new
entrants LuLuLemon and Threadless innovate in women’s yoga apparel and fashion T-
shirts, respectively, by relying on community innovation in product generation and
selection. If community innovation does substitute for firm innovation, the incumbent
may switch its innovation strategy to focus on incremental innovation and scale and
partner with (or acquire) open-oriented new entrants for new products.
IMPLICATIONS AND CONCLUSIONS
Open innovation, enabled by low-cost communication and the decreased costs of

memory and computation, has transformed markets and social relations (Benkler 2006).
In contrast to firm-centered innovation, open innovation is radically decentralized, peer
based, and includes intrinsic and pro-social motives (Benkler 2006; von Hippel 2005).
While the community nature of peer innovation is developing its own literature, and
we understand the nature and social structure of these communities (e.g. O’Mahony &
Lakhani 2011; O’Mahony & Ferraro 2007; Rosenkopf et al. 2001), the impact of this
innovation mode on the firm is not well understood. We do not yet have a theory of
the firm, either for incumbents or new entrants, which takes into account community
innovation. Thus far, the impact of open innovation on the organization and strategy
literatures has been minimal (e.g. see Argote 2011).
The literature in organizational theory and innovation is firmly rooted in the focal
firm managing its transaction costs, minimizing its dependence on its context, and
building absorptive capacity based on R&D and combinative relations with selected
partners. Open innovation, with its fundamentally different organizing assumptions, is
at least a
complement, if not a substitute, for firm-based innovation. If so, our theory of innova-
tion, organizational design and leadership for innovation must be informed by these
contrasting innovation modes. The literature on the management of innovation has been
built on a base of industrial product-oriented research in a world where communication
costs across boundaries were substantial. Exploration now increasingly resides outside
the boundaries of the traditional firm. It is inconceivable that today’s models of organi-
zations and innovation reflect the reality of innovation in a world that is ever more open
and modularized. Our organizational, innovation and leadership literatures need to
reflect and reconcile the implications of open innovation models.
As open and firm-based innovation are based on contrasting assumptions of agency,
control, motivation and locus of innovation, our emerging theories of organizing for
innovation must reflect these paradoxical and internally inconsistent innovation modes.
Our innovation research must move to the institutional level as we explore how commu-
nities inform and shape the firm, and how the firm shapes and leverages its communities
in service of its innovation streams (e.g. Rosenkopf et al. 2001; O’Mahony & Lakhani
2011; Jacobides & Winter forthcoming). Similarly, if open and market-based innovation
are complements and the firm’s boundaries are contingent on the product’s degree of
modularity and knowledge distribution, multiple types of boundaries will be employed
to manage innovation. These boundaries will range from traditional intra-firm interfaces
to complex inter-firm relations (e.g. ambidextrous designs), to webs of interdependence
with partners, to interdependence with potentially anonymous communities. Just how
are the mechanisms associated with leading complex intra-firm boundaries (e.g.
O’Reilly & Tushman 2008) and relations with partners (e.g. Rothaermel & Alexandre
2009) different from shaping relations in open communities (e.g. Fjeldstad et al. 2012;
O’Mahony & Ferraro 2007)?
The theory of innovation and complex organizational boundaries can build on extant
literature on paradox (e.g. Andriopoulos & Lewis 2009) and extend this work to con-
tradictory innovation modes. These paradoxical innovation modes require theory and
research on governance, incentives, intellectual property, professional and organiza-
tional identity, and organizational cultures to attend to these heterogeneous innovation
requirements (e.g. Gioia et al. 2000; Baldwin & von Hippel 2011; Murray & O’Mahony
2007). As so much of this work on dynamic boundaries involves senior leaders making
choices involving contrasting innovation modes in the context of the firm’s history, it is
also important to understand how managers think about innovation and organizational
design in a way that admits these contradictions (e.g. Smith & Tushman 2005; Kaplan
& Tripsas 2008; Smith & Lewis 2011).
Finally, we have focused here on the challenges faced by incumbent firms having to
respond to increasingly open innovation requirements. Much work needs to be done
on the characteristics of new entrants that are born in contexts already rooted in open
innovation. It may be that the founding of firms anchored in open innovation is funda-
mentally different than that of traditional entrepreneurial start-ups. It may also be that
firms like LuLuLemon or Threadless build their initial business models based on open
innovation logic and only deal with more traditional innovation and organizational
dynamics when they go to scale (Lakhani & Kanji 2009).
While the theoretical and research implications of contrasting innovation modes
and associated complex boundaries are substantial, so too are the implications for
managerial choice and agency. If open and firm-based innovation are complements,
firms must chose which tasks will be executed in each innovation mode. We suggest
that these choices are contingent on the extent to which critical tasks can be decom-
posed and the extent to which the tasks’ knowledge requirements are concentrated.
These strategic choices need then to be executed with the systems, structures, incen-
tives, cultures and boundaries tailored to open and firm-based innovation modes.
Further, if the firm is ever more dependent on open communities, how do leaders act
to influence these external communities? Finally, senior teams must build their own
personal capabilities to deal with contradictions as well as their firm’s ability to deal
with contradictions (Smith & Lewis 2011). While building internally contradictory
organizational architectures is difficult (see O’Reilly & Tushman 2011; O’Reilly et al.
2009), building these architectures to attend to contrasting innovation modes will be
more challenging.
In sum, in contexts of increasing modularity and decreased communication costs,
open innovation will at least complement, if not increasingly substitute, for more tra-
ditional innovation modes. We have suggested a set of contingent variables associated
with building organizational boundaries that attend to task and associated knowledge
requirements. As these task requirements are not stable, these organizational boundaries
are inherently complex and dynamic. Further, open innovation is rooted in the ability of
external actors to directly influence the rate and direction of innovation activity, and is
associated with a fundamentally different set of organizing assumptions than traditional
firm-based innovation. This set of contrasting innovation modes, where traditional
firm-based innovation logic is ever more replaced by open innovation and its associated
boundary complexities and organizational tensions, represents an important opportu-
nity for scholars of strategy, innovation and organizations. These challenges also rep-
resent a great opportunity for those leaders and senior teams that can take advantage
of these contrasting innovation modes, paradoxical organizational requirements and
associated dynamic boundaries.
NOTES
1. We sincerely thank Paul Adler, Carliss Baldwin, Anna Grandori, Eric von Hippel and Charles
O’Reilly for their critique and suggestions for improvements for this chapter. All mistakes and
omissions are our own. The authors acknowledge the support of Harvard Business School’s Division
of Research and Faculty Development. The Harvard–NASA Tournament Lab also supported Karim
Lakhani’s work.
2. By ‘open’ we mean that problem-solving needs and knowledge flow both inside and outside the firm via
interaction with multitudes of external actors who could be embedded in communities or participating in
innovation platforms.
3. Markets feature many distributed actors that are working independently, in parallel and often in competi-
tion to solve innovation problems. Communities, in contrast, feature actors that are highly socialized and
are working collectively on interdependent tasks to create solutions to innovation problems.
4. http://www.apple.com/opensource/.
5. Gilson et al. (2009) provide an interesting perspective on Apple’s journey in manufacturing outsourcing
by focusing on its decision to sell its logic board manufacturing plant to SCI along with a parts purchase
contract and a collaborative innovation agreement.
6. Note that in contrast to Figure 19.2, King and Lakhani (2012) do not explicitly concern themselves with
task decomposition: instead they focus on the distribution of knowledge for both the generation and
selection of innovations.
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19.

Open innovation and organizational boundaries:

This chapter contrasts traditional, organization-centered models of innovation with

Abernathy’s (1978) seminal empirical work on the automotive industry examined

communication has catalyzed the emergence of self-organizing communities that

COMPLEX AND DYNAMIC BOUNDARIES AT APPLE

Figure 19.1 Apple and the computer industry

community approach to innovation is grounded on the relative degree of social relations

Strategic Decomposition of the Operating System and Working with Communities

Narrow Problem Solving Knowledge Broad

Figure 19.2 Dynamic boundaries at Apple

Simultaneous Decomposition and Reintegration

INNOVATION AND FIRM BOUNDARIES: THE CONTROL OF

Such paradoxical, internally inconsistent innovation modes require, in turn, organi-

Solution Generation and Selection Knowledge and Locus of Innovation

DRIVERS OF DYNAMIC BOUNDARIES IN INCUMBENT

External Voting and Community

Internal Firm Effort Knowledge Markets: Tournaments

Figure 19.3 Generation and selection knowledge and locus of innovation

LEGO Group’s experience with complex boundaries illustrates how an organization

Themes & Themes &

Narrow Problem Solving Knowledge

Figure 19.4 Dynamic boundaries at LEGO

LEGO’s decision to allow community innovation to flourish resulted in the establish-

NASA – Space Life Sciences

Figure 19.5 Dynamic boundaries at NASA

came from a retired telecommunications engineer. Using only ground-based equipment

OPEN INNOVATION AND COMPLEX ORGANIZATIONAL

NASA: Open Innovation Contests

Automative Supplier Alliances

NASA: Vehicle Design & Manufacturing Community

LEGO: Brick Design, Themes & Scenes,

Narrow Problem Solving Knowledge

decomposition, without the requisite expansion of knowledge distribution, leads firms

IMPLICATIONS AND CONCLUSIONS

Open innovation, enabled by low-cost communication and the decreased costs of

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