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Inside H-P's Idea Incubator

Taking a VC approach, H-P doles out funds to promising technology.

Like a baseball scout hunting for a hot prospect, Hewlett-Packard's (HPQ) - Get Report Phil McKinney has racked up frequent-flier miles and turned over every corner of his home turf.

The object of his quest: the next breakthrough concept with the potential to set H-P's laptop and desktop PCs apart from the pack.

"Those ideas come from everybody. I've gotten them from kitchen workers in the H-P cafeteria," says McKinney, recounting a suggestion for a new type of computer keyboard he picked up while grabbing lunch at the company's Palo Alto, Calif., headquarters.

McKinney will evaluate several hundred new ideas in the course of a year, ranging from computer displays to packaging for computers. Only a handful will get the green light from H-P's innovation program office, the group headed by McKinney, which celebrates its one-year anniversary this month.

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In the increasingly commoditized PC business, McKinney's is an odd role. With success in the PC market largely determined by the ability to drive costs down, spending time and money on innovation seems futile, if not counterproductive.

As growth in the PC market slows from its historical double-digit levels, H-P is using its new innovation program office to find ways to expand the business while maintaining the tight focus on containing operating costs that characterize the company under CEO Mark Hurd.

Borrowing a page from venture capital firms, the group doles out funding to the most promising technology and ideas it finds within H-P and outside the company.

H-P employees are invited to submit their ideas, and if the idea passes muster (Does it fundamentally alter the economies of the industry? Can it generate a sufficient profit margin for H-P?), the worker is temporarily reassigned to the innovation program office.

"We'll pluck that person out, move them into the innovation office and build a team around their idea," says McKinney, who also serves as the CTO of H-P's PC business.

The innovation office's role is to accelerate the development of ideas into commercial products, and once under the group's aegis, it doesn't take long for a particular idea to either get annexed into H-P's product line or to fizzle out.

The development cycle is purposely kept short at 12 months to 18 months. And there are various tests and milestones along the way designed to weed out the unviable.

"Either we hit the objectives or we need to kill that program and reallocate those opportunity dollars to other programs," says McKinney.

Funding for the projects comes out of H-P's R&D budget, which totaled $3.6 billion in the fiscal year ended Oct. 31, 2006. But the group is distinct from H-P Labs, the company's central research arm that focuses on scientific advances.

The group also operates separately from the general R&D projects undertaken by each of H-P's main business units -- including the PC division -- to improve and update their core products.

The mission of the innovation office, by contrast, is to devise ways to extend the reach of H-P's PC business into new markets. That could mean a different industrial design to sell a PC in foreign country. Or a fundamentally different version of a PC, like a so called thin client that might make the machines better suited to businesses that don't typically have PCs.

Roger Kay, president of market research firm Endpoint Technologies Associates, says focusing on adjacent markets makes business sense, particularly as the widespread adoption of PCs in developed countries makes it

tougher for companies to significantly grow sales every year.

"Things begin to slow down and companies need to look around for new ways to extend the markets," says Kay.

Of course, H-P isn't the only company looking to spark PC sales by chasing a broader set of customers.

Dell

(DELL) - Get Report

recently unveiled a low-cost desktop PC specially designed for first-time buyers in China. The product was developed by the company's engineers in Shanghai, according to news reports. And Taiwanese notebook vendor

Acer

sees opportunity in the U.S. PC market, where the company

has signaled it intends to enter the market by means of an acquisition.

Efforts to innovate in new markets don't always strike gold.

Intel

(INTC) - Get Report

and

Advanced Micro Devices

(AMD) - Get Report

each have introduced technologies intended to make

PCs standard home entertainment components, alongside TVs, stereos and DVD players.

But more than a year since their introduction, Intel's Viiv and AMD's Live! have yet to make much of an impression in the marketplace.

"Greater integration with digital devices is promising, but it's not clear that the PC is going to take over that role," say IDC PC analyst Loren Loverde

As with any attempt to tap adjacent markets for new revenue streams, "those frontier areas might or might not represent the future," adds Loverde. "The key is to explore and tap the best ones."

H-P's innovation office has 22 projects in the pipeline, with a goal of bringing two projects to market every year starting in 2008. Among the current projects is a multipanel PC display, code-named Panoply, which will provide a seamless image on a screen measuring several feet.

According to H-P, the technology could come in handy in products ranging from video games and entertainment to certain work applications.

The group is also preparing for public trials of an improved eBook reader that will allow people to read digital versions of books without the eye strain typically associated with the current crop of devices.

Later this year, the first project born in H-P's innovation office will come to market, although H-P is mum on the details.

The innovation office is serving a dual-purpose function at H-P, says McKinney, both "tapping into the passion and energy of employees, and the ultimate objective is to be able to deliver growth engines both on the top line and the margin."

If he discovers the right ideas, McKinney may be able to deliver on all fronts.