To appreciate the important role that outside innovators can play, look no further than Apple Inc.’s wildly successful iPhone. Thousands of external software developers have written complementary applications for the iPhone that have greatly enhanced its value, transforming the product into a blockbuster that has become the center of a thriving business ecosystem. Of course, the fundamental concept of “open innovation” 1 — relying on outsiders both as a source of ideas and as a means to commercialize them — is hardly new, but companies have struggled with precisely how to open up their product development to the external world. For starters, many executives have little idea how to motivate and manage outside innovation. Specifically, should external innovators be organized as a collaborative community or as a competitive market?

Collaborative communities are perhaps best known through the Linux Foundation’s Linux and through other open-source software efforts that are governed loosely by social norms and “soft” rules to encourage open access to information, transparency, joint development and the sharing of intellectual property. A remarkable aspect of communities is that members are often willing to work for free. 2 Competitive markets are strikingly different. Rather than collaborating, external innovators in a market will develop multiple competing varieties of complementary goods, components or services. Customers then choose from among the different offerings. The classic example here is the multibillion-dollar video game industry, where companies (Nintendo Co., for example) develop a hardware console (Wii) and encourage third-party businesses to write game software for that platform. In a market, external innovators are busy focusing on their own economic interests, which often results in fierce competition — and little cooperation — among them.

Because the dynamics of communities and markets are so dramatically different, companies need to consider carefully which approach makes the best sense for their objectives. From our research, we have identified three critical issues that managers should take into account when making that