It's become cliched for companies to say they listen to their customers. Yet how many allow their customers to help change and design their products? That risky practice can nonetheless lead to significant advantages, as Patricia Seybold argues in her new book Outside Innovation.

Seybold operates her own consulting firm, and she's the author of best-selling books like While her ideas may seem far-fetched, she always backs up her positions with in-depth research.

Because of long publishing cycles, books tend to be outdated when they hit the shelves. That's especially true for books about innovation and the impact of technology. Is Seybold's book still relevant? Absolutely. She covers Web 2.0 concepts like wikis, user-generated content, open-source software, online communities, mashups, and so on. She also looks at upstart companies such as Wikipedia, Flickr, and Technorati.

Seybold's solution
Seybold believes that technology now gives customers much greater buying power. The Web makes comparing prices among retailers easy, and companies such as eBay (NASDAQ:EBAY), (NASDAQ:AMZN), and Google (NASDAQ:GOOG) provide message boards and rating systems where consumers can post their shopping experiences.

Seybold suggests that companies need to reach out and engage customers, using the online retailer Karmaloop as an example. The company faces the tough task of finding hip clothes that appeal to urban adults -- so it encourages consumers to send the company tips on the latest trends. Karmaloop decides on 40% of its brands based on the feedback it gets through its website, newsletter, and blog. Additionally, the company's referral program allows customers to get commissions for any sales generated when they link to Karmaloop's site from their MySpace pages, emails, and blogs. This clever marketing method generates approximately 15% of the company's sales.

Going old-school
Even more traditional companies can benefit from outside innovation. For example, National Semiconductor (NYSE:NSM) developed a Web-based portal called WEBENCH, focused on its community of analog design engineers. It's a virtual lab where engineers can prototype, test, and simulate the performance of chips.

National Semiconductor estimates that the insight it gains from this community saves customers 60 man-hours per design, and in the highly competitive electronics markets, that's a big deal. Anyone can register for the free online service, which boasts more than 125,000 members. The site attracts about 80,000 users per day and collects more than 20,000 designs per month.

The downfalls
Outside innovation may sound great, but it's not always easy. Usually, it means giving the entire world access to a company's proprietary databases. Companies also face the risk that customers will be disruptive or even provide bad content. To help ward off this possibility, companies can leverage the communities they create by providing user ratings. National Instruments (NASDAQ:NATI) does so by stratifying its online community's members into "active members," "champions," "veterans," and so on.

Consumer apathy and lack of participation is another possible risk, spurring some companies to create incentives for community members. In Hallmark's private community of 200 influential customers, the company rewards contributing members with monthly gifts.

Innovation is usually messy, unpredictable, and hard to value. It's no longer a matter of spending lots of money on R&D or putting together research labs. Even companies that develop critical innovations may not know what to do with them. Xerox (NYSE:XRX) developed laser printing, Ethernet, and graphical user interfaces for computers during the 1970s, only to watch other firms successfully implement and profit from these creations.

The customer knows best
Seybold's book is a lot of fun and revs up your mind. According to the author, "You no longer win by having the smartest engineers and scientists; you win by having the smartest customers."

Some light Foolish reading:

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Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked 2,142 out of 28,200 in CAPS. The Fool has a disclosure policy.