BY LIISA VALIKANGAS AND GARY HAMEL

Introducing Markets Inside Corporate Hierarchies: Examples

ntroducing markets inside hierarchies is no small task. Combining hierarchies and markets is bound to create tensions on the boundary, yet offer insight into a hybrid organizational form that may have a deeper capability to innovate than a market or a hierarchy alone. It is at this level of governance structures, we believe, that the innovation capability of an organization can best be enhanced. This is because innovation is often a challenge to the hierarchical organization at its core, and hence difficult to address without impacting corporate governance. Creating hybrid structures in our view is the first step toward such enhanced innovation capabilities.

To explore the issue, we have studied during the past two years a number of different cases of corporations that have created functioning markets inside their otherwise hierarchical organizations. We call such markets within hierarchies 'internal markets' for the purposes of this article. The example internal markets differ in their nestedness or integration within a hierarchy: in the first case — a public, world-renowned financial organization — the "market" is an open but separate event that radically differs from traditional strategy making processes typical to the organization. This "market" significantly increased the availability of options for the organization to consider in its mission toward eradicating poverty. In the second case observed, the company's core processes are organized around market principles, and have a dramatic impact on the operational rules and norms the company uses to do its business. These operational reforms amount to a continuous re-pricing of corporate resources in the search for most innovative uses. This is a corporation in the utility industry. The two other examples — a "fast-track" process that invites the development of radical new ideas otherwise ignored by the operating companies in a global oil company — and an extended network to connect a leading computer firm with the software developer — illuminate other interesting dimensions of markets. Namely, such markets help existing businesses absorb new innovation and reap additional benefits from R&D activity. In the process, they release creativity and invite a contribution that makes a difference for the corporate future.

World Bank Development Market Place

The World Bank Development Marketplace is an example of an "event-based market" for matching international aid resources to grassroots development efforts around the world. The Marketplace was created to bypass the traditional centralized decision making channels in the Bank, and to open the door for anyone with an idea to compete for funding of development initiatives. At the 2-day event, some 270 teams of innovators staffed booths in the atrium of the Bank's Washington, D.C., headquarters, February 8-9, 2000, to promote their proposals for addressing some of the most difficult development problems. The Marketplace had a fund of $3 million to allocate amongst some 300 projects, and received 1200 ideas from all over the world.

Though the World Bank is infamous for its heavy bureaucratic ways of working, the Marketplace created — literally — an open market for ideas. It significantly enriched the number of visible ideas for development and increased competition for development aid. For the first time, the organization was able to assess a much larger set of options for development and benefited from local knowledge brought to bear by the people present. Despite being an isolated instance of entrepreneurship on the part of the Bank's Corporate Strategy Group, the event (and follow-up activities) had a dramatic impact on World Bank Strategy — of the 9 current strategic initiatives of the Bank, 4 originally were proposed in the Marketplace. Without the mechanism of the Marketplace, few if any of these projects would have gotten the attention and resources they required.

The World Bank story is an instructive case of bringing a market — even if temporarily — inside a hierarchy. An organization whose mission it is to "eradicate poverty" is in dire need of new, powerful ideas to make progress. Access to such ideas was effectively provided in the Development Marketplace. Clearly, a lot of ideas are needed to find a few promising ones. But at the same time, there probably are no single solutions to the world-wide eradication of poverty, and hence funding multiple small ideas may be necessary. Says James Wolfenson, World Bank President: "We need ever more effective, innovative solutions to meet this challenge. The Development Marketplace can help bring our collective experience, knowledge, and passion to bear in the search for solutions" (World Bank Development Marketplace 2001 Calls for Proposals). The Development Marketplace moved development aid from the domain of experts in a bureaucracy to the reach of laypeople whose lives the aid will (or will not) eventually touch. Instead of the World Bank Pakistani expert owning a regional decision, say, anyone could compete for a solution. Anyone who cared.

Shell GameChanger™

GameChanger is an innovation process developed by Royal Dutch/Shell's Exploration and Production (E&P) division. Its mission is to deliver new business opportunities — specifically, breakthrough or "game-changing" opportunities — to Royal Dutch/Shell. Introduced in 1996, GameChanger solicits ideas from any member of Shell's staff as well as from selected universities and other partners. In this way, GameChanger trades in a market for ideas, rewarding innovators with a variety of remuneration schemes, should their idea become a basis for a commercial venture. However, the GameChanger experience also strongly suggests that people compete for a chance to have their personal vision impact the corporate future.

Unlike conventional new-business-venture groups, GameChanger is not responsible for commercializing ideas. Instead, it facilitates commercialization by providing seed capital and support to those innovators with the most promising ideas, thereby helping them demonstrate proof of concept for their ideas. Once proof of concept is established, GameChanger again looks to the market — the federation of Shell operating companies — for commercialization of the idea. This is the second market in which GameChanger operates. The by now more mature value propositions for innovations need to be 'sold' to one of the Shell operating companies.
To understand why GameChanger operates in a market and not in a hierarchical environment, it is important to note the governance position of GameChanger and the particular nature of the company. The Royal Dutch/Shell Group of Companies is a federation. Indeed, Shell is a minority shareholder in many of its operating companies. Within E&P, GameChanger does not enjoy an elevated status in the organizational structure. It does not, for example, report directly to the Executive Committee, which runs the E&P division. In this environment, GameChanger lacks a governance position from which to influence people. Instead, it must rely on persuasion and the maintenance of good relations with the subsequent business development teams and the many E&P operating companies around the globe.
Operating on a budget of just 0.1% of E&P's earnings in 2000 and staffed with a small team of scientists and engineers, GameChanger has been remarkably successful in bringing breakthrough innovation to the fore. Indeed, in one recent year, four of Shell's five largest growth opportunities derived from GameChanger. GameChanger has received hundreds of ideas, several of which have made an impact in an operating company or have been adopted by the much larger Evolutionary Technology Development Program or Shell's "business accelerator". In some cases, however, innovations have been spun out. For example, a series of GameChanger projects in the area of smart wells during the past several years has culminated in the formation of the new company WellDynamics.

GameChanger's success is in marked contrast to the attempts of many large corporations to support radical innovation through new organizational processes. Since the 1970s, most of these attempts — new-venture divisions, incubators, corporate venture funds, or so-called skunk works — have failed (cf. Chesbrough and Socolof, 2000). They typically failed because they were organizationally isolated, provided limited access to experienced management, and, perhaps most importantly, were hostage to the vicissitudes of the corporate budgeting and strategic planning cycles. GameChanger's independence and its connections with the rest of the corporation combine in a market-like environment to give it the nodal position in the corporate hierarchy without being a corporate subject. GameChanger relies on its ability to make compelling value propositions to operating companies, attract ideas that have future commercial potential, and build credibility to gain access in the organization — access that it cannot mandate but needs to negotiate.

IBM alphaWorks

IBM has never lacked commitment to R&D, and hence, presumably, to innovation. Indeed, last year, IBM invested $6 billion in R&D and filed more U.S. patents than any other company. However, IBM's R&D often takes place in a vacuum. The emerging solution in the domain of software, alphaWorks, represents a substantial reworking of IBM's relationship with the developer community. Moreover, the alphaWorks initiative has transformed IBM's ponderous and process-driven approach to innovation into an approach that is dynamic and market driven.

Since the initiative's 1996 launch, the mission of alphaWorks has remained unchanged: to accelerate the transfer of so-called alpha code (software in its earliest stage of development) from IBM Research into new products. The mission is fulfilled by the alphaWorks Web site, which currently attracts some 400,000 unique visitors per day. It appeals directly to software developers, inviting them to download and tinker with alpha code and then to offer feedback on applications, potential enhancements, licensing requirements, and so on via e-mail, Web-based evaluation forms, and electronic bulletin boards. The bulletin boards are especially important because they enable developers to share tips, fix bugs collaboratively, and exchange ideas as part of the evaluation process.

The exchange between IBM researchers and the wider developer community benefits both camps. Developers gain early access to cutting-edge technology. The alphaWorks site allows the downloading of alpha code free of charge during a 90-day evaluation period. During this time, developers can expand on the code and use it to create technology solutions. This new licensing method, itself the result of developer feedback through alphaWorks, gives developers an option for obtaining leading-edge technologies. And, more significantly, early access can sometimes give them a head start on competitors when exploiting technologies that will quickly become commercially important. By engaging developers early on, alphaWorks secures loyalty among software developers. For IBM, alphaWorks provides critical developer feedback to guide product-development decisions. The alphaWorks team receives about 150 alpha technologies from IBM Research each year, of which some 100 are suitable for posting to the alphaWorks Web site. In a typical year, 46 of these alpha technologies will migrate into new products. Several technologies that first surfaced on the alphaWorks Web site have since undergone commercialization including WebSphere (the best-selling Java application server), XML Parser (an important translation program), and PanoramIX (a 360º viewer for video and multimedia). And alphaWorks is accelerating the time to market of these technologies. Before alphaWorks, IBM would require two or three years to transfer an emerging technology into a commercial product. Today, that delay is down to six months.

alphaWorks is an example of using unmediated market pull to direct technology development. Technologies that might have been ignored can now gain support of the developer community and hence lobby for funding. Technologies that lack the attraction on the market place can be screened out earlier. alphaWorks hence acts as a market barometer for emerging technologies, aggregating feedback from the developers and gaining their eventual commitment to support the technology. Such developer support is valuable currency in a corporate fight for resources.

Some Emerging Conclusions: The Need for a Hybrid Organization?

The above examples start painting pictures of emerging hybrid organizations that combine elements of a hierarchy and a market toward innovative ends. These examples illustrate the need for new organizational forms to solve corporate innovation problems (cf. Powell, 2000). The cases highlight how the World Bank Development Marketplace was able to enlarge its set of options for development aid; how Shell GameChanger enabled the search for white space ideas that no particular business unit was initially interested in; and how IBM alphaWorks used market pull to evaluate the commercial potential of its intellectual property. By the time an idea has attracted tens or even hundreds of colleagues to devote some of their time and energy, it is unlikely to be just another bad idea. And it is likely to arouse a lot of passion on the part of those in the project.

A number of authors have contrasted markets and hierarchies as organizational forms since Coase (1937) and Williamson (1975). Powell (1990), for example, introduces the network form of organizing as something that is neither a market nor a hierarchy but a set of ongoing relationships. In Powell, Koput, and Smith-Doerr (1996), the authors conclude that the motive for biotechnology firms in their transactions with each other was not to minimize such costs but to learn as effectively as possible over time. Indeed, the locus of innovation was frequently found in inter-company alliances rather than within a particular firm. Such findings point to the inadequacy of transaction cost theory to explain innovative behaviors: while hierarchies may excel in exploiting complex, integrated skill sets and strategic assets, they are likely to fail in ensuring the continuing exploration of new combinations of skills and assets for reasons stated earlier. Heterarchy (e.g. Hedlund, 1986) is a form of a hybrid organization: with multiple "buyers" or sponsors for new ideas, a heterarchy escapes the typical monopsony of the purely hierarchical organization. However, while various hybrids — horizontal organizations, project-based firms, keiretsus, and "quasi-firms" (Eccles, 1981) — may address some of the failings of a hierarchy yet perpetuate others, it seems to us we still need a focus on the consequences of organizing for the innovation capacity of a firm.

Hierarchies are organizational solutions to the industrial age: they economize on transaction costs by building scale; they made quality — i.e. basic safety and mass production of exchangeable objects — something that customers take for granted today; and they gave a group of professional managers control of economic resources at a scale unforeseen in the history. As Powell (1990:299) states: "…hierarchies do not represent an evolutionary end-point of economic development". It is likely, therefore, that hierarchies as a form of organizational governance are coming to the end of their marginal benefit, and new organizational forms need to be explored in an era where transaction costs may matter less than the ability to innovate an industry or offering (Powell, Koput and Smith-Doerr, 1996). To do it consistently, companies are likely to need to tap the imagination and creativity of all their employees rather than allocate such privileges to the few on the top or to those whose "job" it is to be innovative (and who will, eventually and inevitably, run out of new ideas) (see Hamel, 2001). Markets are an attractive complementary form of organizing, precisely because they offer the promise of disrupting the rigidities that hamper the creation and development of radical innovations (Hamel, 1999).

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