Let's start with the stories of two acquisitions. In August 2011, Google announced the acquisition of the bulk of Motorola. No one had thought of Motorola as being particularly innovative in a long time, despite the firm's best attempts. Instead, for many years, the company had focused on filing successful patents. Employees who successfully filed patents were rewarded with a bonus of several thousand dollars. Researchers who made at least ten patent filings sported gold-colored employee badges, while those with at least twenty-five wore platinum-hued ones. Additional financial bonuses were associated with reaching these plateaus.
As a consequence, there was a strong emphasis at Motorola on making a large number of incremental patent filings. For instance, Motorola filed fifty patents in the late 1990s for battery latches on wireless phones alone, a feature that drives few consumers to decide whether to purchase a new phone. Each domestic patent filing typically costs tens of thousands of dollars, and international filings many times that amount. Battery latch patents were clearly a losing proposition, and yet still, there they were--most likely accompanied by some snazzy gold and platinum-colored badges.
But a larger consequence of these policies--and Motorola's approach to innovation more generally--may have been even more problematic. The company failed to pursue the innovations that led to a fundamental change in its key markets in the ensuing years. After introducing the stylish, super-thin Razr mobile handsets in 2004, a huge success, the firm struggled to find a follow-up. In its core handset market, the firm failed to understand that consumer demand was shifting from basic phones with stylish design to more complex devices that could handle a wide range of functions, from getting directions to updating one's status on Facebook.
From 2006 to 2010, Motorola fell from number one to number eight in U.S. shipments of mobile handsets. More generally, starting in the late 1990s, the firm made a series of costly blunders that seemed closely linked to a tendency to focus on certain technological avenues and not anticipate the changing nature of market demand: for example, its $5 billion Iridium satellite phone project, which ended in bankruptcy within a year of coming on line, and its competitive reversals in China, where it failed to anticipate the transition to digital technology and the GSM standard.
So it was not surprising that when Google announced its acquisition, analysts argued that the major motivation for the deal was the search giant's desire to get its hands on Motorola's patent portfolio. The key attraction, rather than being any given product, was the large number of patents, which could be employed as a bargaining chip when negotiating cross-license agreements.
The second acquisition started with a massive failure, at least as far as we traditionally measure business success: the peer-to-peer network Kazaa.
In 2000, Niklas Zennström and Janus Friis, along with a team of crack Estonian programmers, had developed the filesharing service. Kazaa allowed users to exchange MP3 music files and other files, such as videos, over the Internet. Kazaa proved to be enormously successful, with over 300 million copies downloaded by 2003. Unlike centralized services such as Napster, by distributing much of the activity to its network users, Kazaa could grow quickly and inexpensively. In that year, Fortune reported, “Kazaa” was the top Internet search term, exceeding Harry Potter, the rapper 50 Cent, and even Paris Hilton.
Alas, all was not rosy. The recording industry soon noticed that users, rather than exchanging home recordings and videos of their pets doing tricks, were instead using Kazaa to busily trade Top 40 songs, movies, and other material that did not belong to them. Despite Zennström and Friis's protestations of ignorance, Kazaa soon became enmeshed in a web of litigation with the Recording Industry Association of America and other powerful adversaries. The founders, who had tried to distance themselves from their creation through a series of byzantine legal maneuvers, were soon on the run, seeking to elude the music industry henchmen who sought to serve them with subpoenas.
It was against this backdrop that Zennström and Friis came up with their next idea, in 2002: a peer-to-peer phone network. Initially, the two had planned to exploit devices that could communicate over Wi-Fi networks. But at the time, these networks--while today seemingly ubiquitous at every coffee shop and hotel on the planet--were still in their infancy.
The two met with the individual who would be their initial venture backer, Howard Hartenbaum from Draper Investment (a firm founded by Bill Draper, the legendary founder of pioneering firm Sutter Hill), and refined their vision. Over the summer of 2002, the three men shifted to a focus on allowing calls from one personal computer to another, during which registered users could talk to each other for virtually nothing. Together, they realized they could work again with the Estonian programming team to build a network that would allow Skype, their new company, to grow rapidly without adding significant infrastructure, unlike traditional centralized Internet-based phone providers such as Vonage. Along with other early investors, such as Bessemer Venture Partners, Index Ventures, and Draper Fisher Jurvetson (run by Bill's son, Tim), Draper invested in and nurtured the firm. The rough idea was transformed into a product juggernaut. In 2005, as the firm's users hit seventy-five million, Skype was purchased by eBay for at least $2.6 billion.
The lesson from these two stories might seem perfectly clear: act more like Skype and less like Motorola.
If only it were that easy.
Despite the importance of technological discovery, the process by which firms and nations innovate is shrouded in mystery. In many cases, misconceptions and misleading stories mask what is really taking place, ambiguities that can lead readers to conclude that innovation is a crapshoot, a random process in which a few get lucky but many fail. Is there any rhyme or reason why some firms, individuals, or nations are particularly innovative while others are not? If the answer is no, the possibility that we will address our critical economic and social needs may be slim indeed.
Innovation can be understood and managed. But many of the most useful insights have been largely neglected by the voluminous business literature on innovation and by many of those who seek to encourage innovation, whether top executives, investors, or policy makers. In particular, far too little attention has been paid to the power of incentives in shaping the behavior of those who design and commercialize innovations.
The sweet spot, I argue, is a hybrid between the systems that produced Motorola and Skype: initiatives that combine the best features of the corporate research laboratory and the venture-backed start-up. In that way, the powerful motivations and focused goals associated with venture capital can be preserved, while the limitations that circumscribe the effectiveness of this intermediary can be overcome.
Reprinted by permission of Harvard Business Review Press. Excerpted from The Architecture of Innovation: The Economics of Creative Organizations . Copyright 2012 Harvard Business School Publishing Corporation. All rights reserved.
Josh Lerner is the Schiff Professor of Investment Banking at Harvard Business School and co-director of the Productivity, Innovation, and Entrepreneurship Program at the National Bureau of Economic Research. He is recognized worldwide as an expert on how innovation works. His other books include The Venture Capital Cycle , The Money of Invention  (with Paul Gompers), Innovation and Its Discontents  (with Adam Jaffe), and Boulevard of Broken Dreams .
[Image: Flickr user Darwin Bell ]