EXHIBIT 1.1. Deciding Whether to Lead or Participate in an Ecosystem. Source: authors’ research.
Addressing the Disruption Imperative
THE SHOCKWAVES IN DETROIT WERE ALMOST DEAFENING. The world had just learned that Tesla Inc. had surpassed the market capitalization of General Motors (GM) to become the most valuable automaker in the United States.
A week earlier, it had overtaken the value of Ford, the company that had pioneered the modern auto industry. GM and Ford had 225 years of experience in the automobile industry between them—while Tesla had all of 15 years. Tesla sold 84,000 vehicles in 2016 compared with GM’s worldwide sales of around 10 million vehicles and Ford’s 6.6 million. Some questioned the wisdom of these valuations given Tesla’s position as a minnow in the industry that had yet to deliver a profit.1 The sceptics were not wrong; stock market sentiment had changed by the end of 2017, and GM’s share price had surged by close to 30 percent while Tesla struggled with the basics of building a car and rolling out its new mass-market Model 3. However, despite these misgivings, it was proof, if proof were needed, that the auto industry had entered a period of disruption.
As far back as 2011, Bill Ford, who headed up one of the most successful automakers of all time, had recognized that selling more cars simply “wasn’t going to cut it” either for Ford or for the industry.2 The emergence of electric vehicles, car sharing and ride sharing, and autonomous driving technology promised to radically transform the automotive industry and undermine car makers’ traditional business models.
New players were entering the space, including Uber and technology companies such as Google and Apple. In the words of Bill Ford, “We now have disruption coming from every angle, from the potential ways we fuel our vehicles to the ownership model.”3 Ford’s former CEO Mark Fields echoed that sentiment in 2015, noting that the auto industry was at an inflection point, with technology driving rapid innovation and “new, non-traditional partners and competitors now interested in our business.”4
While incumbent automakers retained their competitive advantage in manufacturing and brand, they were at square one when it came to technologies such as autonomous driving and car sharing/ride sharing applications. The impact of car sharing, as pioneered by Zipcar in 2000, could prove to be significant. Research has found that a single shared vehicle in developed, urban car-sharing markets replaces the purchase of 32 vehicles. The study estimated that car sharing had already displaced 500,000 car purchases and had the potential to cause 1.2 million lost vehicle sales through 2020.5 More recently, a leading industry analyst had suggested that the emergence of shared driverless cars could lead to a 40 percent drop in US auto sales over the next 25 years.6 It was clear that the world’s established automakers would have to fight to stay relevant.
More and more companies in a wide range of industries are facing similar disruption to their traditional formulas for making money that have served them well for decades. The music business has been up-ended with the rise of new ways to consume music. The top twenty brick-and-mortar retailers in the United States announced that they had shut down three thousand stores in 2017. Macy’s, J.C. Penney, Sears, and Kmart were just a few of the chains that had announced sweeping closures.7 The major restructuring of the French retail giant Carrefour in January 2018 was yet another example of the consequences that e-commerce had on the traditional retailers. In 2017, the Financial Times identified four more industries ripe for disruption by technology, the sharing economy, start-ups, and new business models: Travel agents; manufacturers and distributors of small components, in part because of 3-D printing; financial advisers, with the rise of robo-advisers; and auto repairers due to low-maintenance electric vehicles and fewer accidents with driverless cars.8 The banking industry too is poised for disruption by blockchain-based financial services and other forms of “fintech.” Other sectors such as fast-moving consumer goods (FMCG) are being disrupted by the greater consumer choice and price transparency that comes with online marketplaces. Their media strategies are being challenged by social media, and calls to guarantee the sustainability of their products and traceability in their supply chains, along with the prospect of new technologies that allow consumers to personalize the products they buy, are further disrupting their extant business models. New technologies also mean that instead of selling jet engines, companies such as Rolls Royce, Pratt and Whitney, and General Electric sell “aircraft power by the hour.”9 Companies like Michelin sell road kilometers instead of tires. In effect, new technologies such as digitalization, the application of big data analysis and machine learning, and artificial intelligence (AI) are disrupting business models in industry after industry.
How should you deal with the wave of disruption that will eventually hit your industry? How do you become one of the disruptors? The specifics of successful strategies will obviously vary with the situation. However, we believe they all share one characteristic: A successful strategy, in the future, will depend on how well you proactively lead your ecosystem, by engaging with different partners who bring fresh competencies and capabilities that will fuel innovation and transform your organization. You need to catalyze a deep and vibrant ecosystem of partners around your company. This goes far beyond working more closely with your supply chain, open innovation, or co-innovation with your customers.
The nature of innovation is changing: Instead of just product and process innovations, customers are now demanding innovative, integrated solutions to complex needs and problems. To deliver these integrated solutions you will need to access the capabilities of partners, drawing on know-how and capacity in a wide variety of related industries.
The potential to reap economies of scale has also changed. In the past, scale economies were driven by your company’s size. Today and tomorrow, the benefits of scale will increasingly depend on the total sales of your ecosystem, including both you and all of your partners.
The concept of competing on speed also needs to be rethought. Companies used to think about speed as being “first to market.” Today, however, launching your product or service ahead of competitors is a poor predictor of who will come dominate the market. Instead, the winners are increasingly those companies that are first to scale up an innovative idea. Speed to scale, capitalizing on the magnitude of the opportunity rather than simply opening it up, is key. Harnessing the network effects that your ecosystem can provide, where every additional user increases the value of the product or service to all the other partners and customers in the ecosystem, is frequently decisive in winning the race to scale. The Facebook ecosystem, for example, reached five hundred million users in 2010, just six years after the company was founded.10 That same year, MySpace users declined to seventy million, having plateaued at just over one hundred million users.11 This was despite being launched one year earlier and the backing of its huge new owners, News Corporation. Speed to scale had won out. While Myspace went into decline, two years later Facebook had surpassed one billion users. It now has over two billion active monthly users.
To benefit from these fundamental shifts in the competitive landscape requires a radical transformation of your business model. It involves learning to proactively catalyze, shape, and lead an ecosystem in ways that will harness its potential to radically transform your business model to cope with disruption, uncertainty, and rapid technological change. It means learning to thrive in a world where competition that pits one ecosystem against another replaces rivalry between individual companies.
Catalyzing the development of a powerful ecosystem around your company will also transform your prospects by giving you what we call the “ecosystem edge.” It will help you leverage powerful network economies; focus your company on what it is really good at; enable you to harness the power of partners in the areas where they excel; and help you innovate faster, become more agile, and grow in a world where digitalization is now infusing every industry. These benefits are now more than “nice to have”; companies must transform themselves by creating ecosystems today in order to survive and prosper tomorrow.
To understand the practical steps you and your team can take to achieve the ecosystem edge, we focus on eight core examples in this book: Alibaba Group, Amazon.com, ARM, athenahealth, Dassault Systèmes S.E., The Guardian, Rolls-Royce, and Thomson Reuters. We selected these firms from a variety of different industries to demonstrate that it is not only platform players or e-commerce companies that can harness the potential of ecosystem advantage. There is also huge potential for companies in traditional industries, such as manufacturing, mining and energy, pharmaceuticals and life sciences, and fast-moving consumer goods (FMCG), to enhance their success and respond to industry disruption by embracing ecosystem thinking. We also selected these case studies from different continents: an ecosystem is not unique to a particular location. We found ecosystems delivering innovation, greater scale economies, and increased profits both in industrialized and emerging economies.
In order to explain what this entails, let’s begin by taking a look at Alibaba, China’s giant e-commerce company, which has transformed retail in China and beyond through its many innovations.
Alibaba: The Power of Ecosystem Advantage
Alibaba Group is one of the best examples of an organization that has successfully leveraged the power of its ecosystem to gain competitive advantage. At its initial public offering (IPO) on the New York Stock Exchange in September 2014, this Chinese conglomerate was valued at over $225 billion.12 Its market capitalization has since soared to reach almost $530 billion in January 2018. The group and its affiliate companies span twenty-five business units that include the world’s largest business-to-business marketplace (Alibaba.com), business-to-consumer e-commerce (Taobao and Tmall.com), online payment (Alipay.com), and cloud computing (Aliyun.com). More recently, it has expanded into new areas, including digital media and entertainment, credit scoring, travel services, and virtual mobile telecommunications. Its affiliate, Ant Financial Services Group, includes the world’s largest money market fund, Yu’e Bao, which had 325 million customers and assets exceeding $170 billion by early 2018.
For the year ending December 31, 2017, Alibaba Group’s revenues exceeded $39 billion. Yet it had achieved this massive scale and spread of operations with little more than sixty-six thousand employees (with just seven thousand more in Ant Financial, itself estimated to be worth more than $150 billion in 2018). The Group’s e-commerce businesses were more than twice the size of Amazon.com, a company with over five hundred fifty thousand staff. So how did Alibaba achieve such results, recording annual sales revenues of over $590 thousand per employee?
The first clue as to how Alibaba has created so much new value can be found in the opening paragraph of the Group’s website: “We operate an ecosystem where all participants—consumers, merchants, third-party service providers and others—have an opportunity to prosper.”13 Alibaba had come to believe that the route to success lay in understanding how to enhance its own competitive advantage by promoting and leading the development of its ecosystem developed with time and experience. Key to this was a focusing on the creation of attractive opportunities for an increasingly diverse range of partners.
But Alibaba’s journey also shows some of the hurdles that must be overcome to gain an ecosystem edge. Learning how to harness the power of its ecosystem was not always easy for the Group. Alibaba had started out as a classic intermediary between buyers and sellers. Learning to become an ecosystem enabler required it to make difficult choices that included abandoning some of its existing profit streams. In the face of huge uncertainty, and accepting that a large network of partners would never be fully controllable, Alibaba’s founder, Jack Ma, had a strong belief in the power of the ecosystem model.14 To date, this belief has proven right.
Alibaba’s experience with its Taobao and Tmall.com units illustrates some of the key characteristics of ecosystem strategies and the requirements for its success. In 1998, Ma was asked by a company sponsored by the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) to assist Chinese companies to become involved in “electronic commerce,” based on private networks, to facilitate electronic data interchange. Ma believed the real potential lay in open networks enabled by the Internet, and so he gathered eighteen people in his apartment and outlined his vision in a discourse lasting two hours. The group was so inspired that they clubbed together $60,000 to launch “Alibaba”—a name they felt embodied the idea of “open sesame to the treasures of the world.” Alibaba’s origins thus trace back to 1999, when it first launched the website Alibaba.com, a business-to-business (B2B) portal to connect Chinese manufacturers with overseas buyers.
Alibaba did not have a clear vision of what their future ecosystem would look like at the time. The idea was simply to make the internet accessible, trustworthy, and beneficial for all. Those noble aspirations, however, were not enough to ensure that the new venture was financially sound. Alibaba.com had a rocky time in its early years. Although it earned a margin by selling products through its site, the costs involved in handling new products (such as uploading and maintaining product details on the site) was high. By 2001 it was burning through the $25 million funding it had raised from investors, such as Japan’s Softbank, Goldman Sachs, and Fidelity, at the rate of $2 million per month, and was left with less than $10 million in the bank.
The first phase (of three broad stages) in Alibaba’s transition to becoming an ecosystem enabler came in response to this cash drain. Alibaba moved from a pure platform intermediary to become a service provider, charging membership fees to users. It had already recognized that reaping economies of scale was critical to spread fixed costs and drive down unit costs. But it now understood that it would never achieve the scale it was aspiring to if it continued to act as a principal buyer or seller in its own right. For that massive scale, Alibaba would need to start thinking only about growing the size of its own operations to harness the power of a huge number of partners who could take the business beyond its own limited capabilities at the time. That, in turn, meant making it easy for partners to develop their own businesses, limiting its own activities, and focusing on selling Alibaba’s support to potential buyers and sellers.
The launch of Taobao heralded the second stage in developing an ecosystem: Taobao was conceived as a marketplace that encouraged others to serve customers. Alibaba role was to concentrate on providing the “platform” through which e-commerce could flow, and take a commission for connecting buyers and sellers. It was evident that the platform would need to be standardized as much as possible to gain scale economies. Additionally, partners needed to be able to differentiate themselves on that standardized infrastructure platform. To achieve this mix of standardization and differentiation, limiting the boundaries of the platform would be key.
“Our objective was to develop a platform of infrastructure that can attract a wide range of partners and boost growth and scale,” recalled Wang Jian, then chief technology officer of Alibaba Group. He went on to explain that Taobao had spawned a myriad of partner businesses: from companies that designed sophisticated shop-fronts for vendors and creators of advertising right through to companies that recruited models for photo shoots. Wang Jian also drew attention to Alibaba’s policy of nurturing small partners, and commented, “Small customers can become big customers, so the technology for both should be the same. Alibaba wants to make sure small customers have a future.” But during phase 2, Taobao was still acting as a kind of intermediary or “middleman” between buyers and sellers. That had to change. As Ming Zeng, the then group strategy officer put it, “We realised our ability was so limited compared to the potential of the market as well as the task facing us.” As Taobao developed, “it learned a lot of painful lessons by trying to over-control and becoming the bottleneck,” he added.15 The need to step back and move from intermediary to ecosystem orchestrater, was one of those key lessons. And because it meant surrendering significant control to partners, it was a difficult truth to swallow.
This led to a third stage in the emergence of ecosystem thinking at Alibaba: that it needed to become an “ecosystem enabler” and focus on becoming a provider of e-commerce, infrastructure, and services for all e-commerce market participants. Doing so would allow Taobao to gain the network advantages associated with large numbers of buyers and sellers. If Alibaba could position Taobao as “the place to go” for consumer e-commerce, it would trigger a positive spiral whereby the larger it grew, the more attractive it would become for buyers and sellers. By 2008, this thinking had led to the adoption of the “Big Taobao” strategy that aimed to encourage a large number of diverse potential participants to join and exploit new opportunities while addressing their challenge of reaching out to the vast but underdeveloped Chinese consumer market. The idea of becoming the leader of a thriving ecosystem with its own momentum, driven by partners joining and exiting, expanding in new directions, had taken root.
In order to successfully transition from an intermediary to ecosystem enabler, Taobao needed to reduce its role as the controller of activities around the platform. It now encouraged shop owners to take the initiative of working with other participants in the ecosystem, such as other sellers, providers of complementary services and the online shoppers themselves. It thus began to encourage shop owners to organize more joint marketing activities, and to work more directly with providers of other services that could improve their offerings.
This shift of focus to becoming an enabler for the development of a broader and deeper ecosystem around Taobao and Tmall.com also required Alibaba to change its revenue model. In 2009, advertising made up 85 percent of the revenues of Taobao and Tmall.com, and came from various sources including paid items appearing prominently in search results and additional fees for prime advertising positions on the sites. But reliance on these advertising and transactions fees would have to be reduced in order to enable the growth of the ecosystem and improve service to customers. Growth in Alibaba’s revenues and profits would have to come from Taobao and Tmall.com opening new revenue streams and sources of value from which Alibaba could capture a share. As Ming Zeng explained to us, “Because you are no longer taking a cut as a middleman, an ecosystem enabler has to be continually finding innovative ways to create new and unique value added from which it can take a profit. Revenue growth will come from taking a small cut on an ever-expanding volume of interactions of many types.”
To become an ecosystem enabler, Alibaba had to learn, therefore, to stop doing things; in some cases, even things that had become sizeable activities, such as running special promotions for some product categories. Some of these decisions were relatively easy, while others were more difficult. Observed Wang Jian,
It was very clear that Alibaba should not sell products—but the boundaries of the ecosystem are not easy to determine. Take software services. In principle, Alibaba knows it should leave them to partners, but in the short-term partners may not be willing or equipped, and so it would be easier for Alibaba to provide this service. But that would lead to unsustainable complexity and fragmentation. The solution hitherto has been for Alibaba to provide the basic building blocks, such as the exchange platform and a very rudimentary CRM system for every shop owner on Taobao. Alibaba is clear that it will not provide anything that is useful only to a single seller or even a small group of sellers—it must be offerings that are used by large numbers of participants.16
To maintain the health of the ecosystem, Alibaba also found that it was critical to resist the temptation to encroach on its partners’ businesses. Brian Li, then vice president of strategy, explained, “Someone in Alibaba will, perfectly reasonably, say: ‘we see a new application is becoming popular, why don’t we build one to do this?’ But a good ecosystem leader needs to say ‘no’; we should instead encourage partners to build this type of app, so that we draw on their capabilities and drive improvement and learning. By [Alibaba] taking this approach, users now have a choice of multiple apps within our ecosystem.”
Fundamental to Alibaba’s thinking was the belief that if it could create value for the end customer, it would find a way to earn money for itself. This meant focusing first on creating customer value, and then thinking how to capture and share a portion of that value. The Wangwang instant messaging feature on Taobao is a good case in point. It is of great value to buyers and sellers; it helps to build trust. Alibaba also learned that many Chinese buyers wanted to see the physical address of the seller on the website before they would trust them; so Taobao provided addresses even though suppliers argued that it was unnecessary in a world of electronic commerce. Likewise, Alipay ensured that the net proceeds of each sale were transferred to sellers once the delivery had been acknowledged by a buyer—in contrast to competitors such as 360buy which kept the money for a month after the sale to enhance their cash flows.
Ming Zeng explained how this fit into Alibaba’s ecosystem thinking, “Alibaba is a hub, so everything needs to go through it. Conceptually that enables you to charge a toll for passing through, which is our revenue. The higher the flow through, the more our revenues.”17 It was through this change in mind-set that Alibaba was able to create new business models to deliver growing profits.
An example of the new business model is the creation of “Taobao Ke,” a traffic aggregation system developed by Alibaba’s employees that won a CEO Innovation Award from Ma. Taobao Ke aggregates and analyses user data from more than five hundred thousand websites, receiving data on billions of page views per day. It starts by Alibaba agreeing with a website to carry a link that would direct potential customers to a Taobao store. The owner of the shop on Taobao agrees to pay a commission of around 10 percent of the gross sales when a lead comes through that website. The website owner receives 90 percent of that commission and Taobao retains 10 percent (or 1 percent of the gross sales value achieved). This kind of arrangement was common across the internet. But Taobao Ke developed new ways of adding value from analyzing and using data to improve the match between a Taobao store and the websites to which it was linked to achieve that required technology-heavy capacity that could analyze in an automated way the contents of a website, and also work out which of the one million-plus Taobao stores were most likely to be of interest to its users. Alibaba then proposes the optimal links to both Taobao storeowners and websites. This improves the value and efficiency of the arrangement for both parties. Alibaba adds even more value by making the system dynamic, using the mass of data accessed through Taobao Ke to continually learn and improve the matching between Taobao stores and other websites.
Taobao Ke is, therefore, an example of the kind of co-learning opportunities that ecosystem thinking creates. Storeowners learn more about what kind of websites are useful “shop windows,” as it were, to attract businesses. This could even vary by time of day or location. A wide variety of websites (including noncommercial information and community sites) would understand how to create a new revenue stream from click-throughs. Utilizing this new knowledge generated a growing profit pool. The partners improved their yield from each visitor. Alibaba itself generated a substantial stream, taking a small toll from each of the between five hundred million and one billion users that moved through Taobao Ke every day.
While Alibaba could not completely control its ecosystem, it could play a leadership role by acting as an enabler and catalyst for the development of the ecosystem. As a pivotal player in the ecosystem, it could influence and shape its future evolution. On the other hand, there was also a downside of being the hub in the ecosystem because, as Ming Zeng says, “every problem comes at you.” Despite this burden, he also pointed out a corresponding upside, “You are sitting at the hub of a system that generates lots of new knowledge so you can continuously learn from experience, problem solving, learning by doing, and contact with the front line.”18 Hence, being at the center of all flows of information gave Alibaba the opportunity to steer the whole network in ways that generated new value and profit streams, without actually controlling it.
Alibaba also discovered another insight that all ecosystem leaders need to take on board: a recognition that knowledge creation in the ecosystem is much greater than your own learnings—even as the “ecosystem leader.” Considerable learning also occurred between partners within the ecosystem, which could improve performance and strengthen the ecosystem even when it did not involve Alibaba directly. Sometimes, Alibaba needed to tap into the cross-communication and learning taking place between partners to help the process of discovering new value and profit opportunities along. At other times, that intervention was unnecessary.
The social networking sites around Taobao were a good example of why Alibaba had to reassess continually what role it should play. Alibaba had originally set up a social network site called Tao Jianghu within Taobao, with the aim of connecting younger users and creating a buzz in this group around the site. Over time, many similar social networks emerged around Taobao. None reached a scale sufficient to support the Taobao ecosystem as a whole; and instead, the proliferation of small social networking platforms created internal competition within the Taobao ecosystem. As a result, Alibaba had to take the initiative, and catalyze the growth of a single, vibrant social network that would match the Taobao identity and support its business model.
The success of Alibaba illustrates many of the advantages of ecosystems that we advanced above: ecosystems can generate new sources of customer value; enable new business models; access diverse partner capabilities and knowledge; and reap huge network economies. Alibaba also demonstrates how an ecosystem can ignite a positive spiral where successive improvements in the offering combined with easy access and greater choice attracts yet more customers. This growing customer base, in turn, attracts new partners who bring new capabilities and ideas that further improve the quality and convenience it offers to customers.
Alibaba’s experience also provides our first inkling into some of the things an ecosystem leader needs to do to catalyze, foster, and leverage their ecosystem: provide a compelling vision of the opportunity; step back and make room for partners; foster joint learning among partners; capture the data and knowledge the ecosystem generates to open up new revenue streams; and focus on the increased profits that come from enabling the ecosystem to grow rather than squeezing it dry for short-term returns.
The Case for Ecosystem Strategies
The kind of radical transformation Alibaba has achieved in e-commerce and many other consumer services in China is not limited to new emerging economies. New business models from personalized autonomous transport through to digital music or mobile e-commerce are now creating a wave of change across most industries all around the world. Ecosystem strategies enable you to retake the initiative in the face of these disruptive forces by allowing your company to flexibly harness the new and broader range of partner capabilities necessary to underpin these new business models. To succeed in an industry ripe for disruption requires access to capabilities and experience outside the orbit of existing players, such as knowledge of other industries, different distribution channels, alternative marketing approaches, new ways of interacting with customers, and novel technologies. Ecosystem strategies are ideally suited to unlock access to this new knowledge. And properly executed, they enable you to leverage this new knowledge to reap massive network economies that far exceed the traditional economies of scale available to any company acting alone.
They can also help you successfully tackle some of the pressing challenges many business leaders face today: the dilemma of meeting rising customer demands while keeping your company focused on what it does best; the challenge of delivering more innovation, faster; and the need to make your organization more agile.19
Additionally, ecosystem strategies allow you to meet the rising demands of customers for more functionality, more customization and personalization, and solutions rather than simply products—while staying focused—by leveraging the capabilities of partners to provide many of the pieces of a broader offering. Unlike classic outsourcing, which often acts as a straightjacket on the contributions of partners, engaging them in your ecosystem allows you to harness their capacity for innovation, learning, and flexibility, as well as their specialized capabilities. These benefits flow from the fact that in an ecosystem partners coordinate their investments, jointly innovate, and continually evolve out of self-interest, not because of inflexible contractual obligations. And as more partners and customers are attracted to the ecosystem, you are likely to benefit from the network economies we mentioned above. The larger and more diverse set of partners and customers the ecosystem engages with, the greater will be the benefit to each individual participant, including your own company. Being part of this positive spiral will enable you to reap economies of scale from across the entire ecosystem, far beyond your own size.
Proactively developing your ecosystem helps promote innovation that can benefit your business. Business ecosystems can deliver more innovation because they access a wider range of ideas, experiences, and capabilities through a multitude of partners than is available to any company alone, or even to a tightly prescribed alliance. As partners form new relationships and interact in new ways, they generate learning that enables innovation in what is offered to customers and the ways it is produced and delivered. And as new partners join the ecosystem, they continually enrich this diversity, helping fuel creativity and speeding up the pace of innovation.
Ecosystem strategies can also help your organization become more agile. Some of that increased agility comes because leveraging an ecosystem enables you to harness the power of a large, dynamic, and partly self-organizing network of partners to help you serve your customers. Like a living organism, the ecosystem continually evolves and adjusts to meet their changing needs. As the leader of the ecosystem, your own organization needs to adjust the way it gets things done so that it can effectively leverage an ever-changing partner network. These new roles, processes, and leadership styles that you will put in place will further help transform your existing structure into a more agile organization.
Making It Happen
This book explains how your business can become more successful in a world of disruption, uncertainty, and rapid technological change by gaining this ecosystem edge that comes from proactively catalyzing, shaping, and leading a business ecosystem in ways that will harness its potential. We cast you, the reader and your company, in the role of the “ecosystem leader” in an ecosystem. Indeed, many observers of ecosystems have stressed the key role of a hub or keystone company, or ecosystem leader as we term it, to provide the stability for the development of the ecosystem and its final success in stimulating innovation.20
As the ecosystem leader, you cannot completely control that ecosystem or prescribe its precise structure. Nor can you play the role of an omniscient dictator, moving around all the chess pieces and interceding between them. Instead, you play an active role in stimulating and shaping the business ecosystem around your company by using smart power, rather than by imposing strategies as the largest or most resource-rich participant.21 We will show how, by promoting and guiding the development of your business ecosystem as an ecosystem leader, you can enhance your company’s competitive advantage and its ability to generate sustainable profits.
We will also show how leading the development of a vibrant ecosystem will allow you to benefit from the opportunities and deal with the uncertainties associated with the new wave of creative destruction, rather than falling victim to it. As we have already seen, industry disruption challenges companies to find ways to bring together new combinations of technologies, know-how, experience, assets, and capabilities that no single company has at its disposal. That means creating strategies and organizational structures that bring the potential power of partnerships to the fore as core to your business model and future success. It also means leveraging the power of a diverse and changing set of partners, many of whom you can influence but not control, to accelerate learning, experimentation, and innovation in your organization.
In short, it is time to get serious about harnessing the full power of your business ecosystem. This ecosystem is the network of organizations and individuals around your company that can co-evolve their capabilities and roles, and align their investments to create additional value and/or improve efficiency,22 and this to the benefit of all partners in the ecosystem.
The good news is that your company already has the kernel of a business ecosystem. No company is an island; it depends not only on its immediate customers and suppliers, but also on its customers’ customers, end users, providers of complementary products and services, governments, those who contribute to training its workforce, and many others. A few are formal “partners,” but many beyond these formal partners impact the success or failure of your business by their actions, investments, and learning. Some of the broader participants in your company’s ecosystem are identifiable. Others, such as specifiers that set the directions in your industry, opinion formers, or those developing tools that help users deploy your product or service, may have an important impact on your business without you even being aware of them.
Your first reaction might be “So what? I cannot control my ecosystem. I might even not be aware of it.” Look at it this way. Few executives doubt that positioning their companies in their markets is a key element of strategy, even if the market dynamics are outside their control. But back in the 1950s, when most companies felt themselves to be at the mercy of market forces over which they had little influence, the idea seemed radical. Similarly, a strategy that depends on shaping your ecosystem might seem similarly radical today. Smart companies are leading (although not fully determining) the development and behavior of their ecosystems in ways that help make them more successful, and their businesses more innovative and more sustainable.
Another reaction may be: “Yes this sounds good, but it can only be done by a large company like Alibaba. I am a smaller player; how can I do it and what is in it for me?”
Ecosystems Strategies Are Not Only for Large Companies
To see how ecosystem strategy can provide the key to rapid growth for start-ups and medium-sized companies as well as large, established players, we can look to ARM, an information technology hardware company from the UK. Despite limited resources this small company, a world away from the crucible of Silicon Valley, became a leader in an industry that normally requires huge capital investments. They did so by building a very successful ecosystem for the design of its chips.
ARM started with twelve engineers in a fourteenth-century barn near Cambridge in the UK in 1990. At the end of July 2016, Japan’s Softbank paid $32 billion, 43 percent above ARM’s closing price, for a firm with sales of just $1.5 billion, and profits before taxes of $500 million. This looks like a high price for a relatively small company, even if its profitability was impressive. Why was ARM so valuable?
ARM is not a household name even though almost all of us are indirectly its customers. One reason is that ARM is a pure IP (intellectual property) company that designs, but does not manufacture, a specific type of microprocessor known as reduced instruction set computing (RISC) chips. These chips use fewer instructions. Thus, the devices that use them consume less energy than conventional designs. That makes it possible for you to use your smartphones longer without running out of power. The processors based on ARM’s designs are used in over 95 percent of all the world’s mobile phones, as well as other mobile devices and more recently in intelligent devices that can talk to each other over the internet. Most of your smartphones and tablets, your smart watch, and the GPS in your car all likely use ARM’s processors.
One of ARM’s attractions to Softbank is that it benefits from participating in a fast-growing market. We hear the buzz about smart cities, the Internet of Things (IoT), wearable technology, driverless cars—all of which require processors of the type that ARM helps to design. But paying $32 billion for a company with fewer than four thousand employees with no manufacturing capabilities and only producing IP—wasn’t that a bit over the top?
The price was paid, we believe, not just for ARM’s tangible assets, but also for its unique innovation ecosystem. It is another example of how ecosystem strategies can generate massive value for shareholders as well as customers and partners. ARM had created an extensive network of partners that co-innovate and codevelop with it. These partners are chip designers, manufacturers, and distributors (e.g., Samsung, the producers of equipment for design and testing of chips), the original equipment manufacturers (e.g., Apple for its iPhones or Huawei), and of course also the app developers and content providers. Some partners design processor chips based on ARM’s IP; others have fabrication plants that produce the chips. ARM is a master at orchestrating this network—without controlling all the participants. How can it do so? After all, it is a relatively small company and it has to lead an ecosystem with giants. Given the capital requirements for building chip fabrication plants, it could never have succeeded in doing so in-house. But it was successful with its intellectual property (IP) development because it had established itself at the center of knowledge exchange between diverse partners. The key was to create an ecosystem where, by working with ARM, partners could together achieve lower costs, better use of expensive wafer-fabrication capacity, and a faster rate of technological advancement than acting alone. We will describe in more detail this knowledge network and how ARM catalyzed its emergence in chapter 3.
An important lesson here is that small innovators can be as successful as their larger counterparts by using their soft power to lead an ecosystem of innovators. ARM is good at mobilizing and guiding an international network of knowledge partners that stretches from Munich to Melbourne, San Francisco to Seoul, and Guangdong to Geneva. And although some of the participants in its ecosystem are huge companies such as Apple, Huawei, and Samsung, ARM has been able to take on the mantle of ecosystem leader in the network.
ARM’s success in creating enormous value by in-building and leveraging its ecosystem is all the more remarkable because it has achieved this in an industry where the conventional paradigm is one of vertical integration. Trying to replicate the kind of integrated operations Intel has built up would have required an investment of billions of dollars. ARM was launched with an investment of less than $3 million. But by clever leadership of the ecosystem, it was able to not only break in, but also to become a pivotal player. One important lesson here is that the ecosystem leader needs to control the temptation to become too greedy. Like Alibaba, it knew when it had to leave a juicy chunk of value for its partners to keep them motivated and engaged. ARM was highly profitable, but it was also willing to share a fair slice of the value created in the ecosystem with its partners. As one ARM executive told us: “We get rich if our partners get rich.” Thus, ARM’s partners were motivated to scale the ecosystem quickly. As the ecosystem grew, so did ARM, enabling it to grow without the capital necessary to build its own distribution machine.
ARM’s experience also demonstrates that it has been astute in the way it used this ecosystem to innovate as a small company in the high-technology sector. Therefore, it has virtually no competitors. When Softbank bought ARM, it was actually tapping into a collaborative innovation engine that involved a vast network of companies.
To Lead the Ecosystem or Simply Participate?
Whether you are running a large company or a smaller one, we have adopted the perspective of ecosystem leader to explain how you can harness the power of partners to make your business more successful. But there are also many lessons in this book for companies who choose, instead, to become active participants in an ecosystem led by someone else. These include how best to participate in the process of discovering new value; speeding up your pace of learning and innovation; interacting with other partners in the ecosystem; and, importantly, monetizing your role in the ecosystem.
As we embark on the journey to understand how to leverage an ecosystem to thrive in a world of industry disruption, the question of when it makes sense to take a leadership role versus participating more or less fully must be considered. A useful way to structure this decision is to think about two dimensions of your relationship with your potential ecosystem partners.
1. How pivotal is your potential role in the ecosystem? Or to put it another way, how much will your partners need to depend on you?
2. How critical will any specific partner be to successfully executing your future business model? In other words, how much will you need to depend on a specific partner?
The answers to these two questions interact to determine the four possible routes you might follow as depicted in exhibit 1.1. If you have the potential to play a critical role in enabling the ecosystem system to deliver its value proposition, then it makes sense for you to try to adopt the leadership role and catalyze and shape the development of the ecosystem in ways that benefit your business. As we saw in the case of ARM, even a relatively small company can become the ecosystem leader if its potential to contribution is essential to the ecosystem delivering value to customers and other partners. But you will probably be able to assume this role only if you are not heavily dependent on a specific partner who is also vying to lead the ecosystem. Again, ARM’s experience is instructive here. ARM is heavily dependent on its partners to deliver its ecosystem’s value proposition in RISC chips. But it need not be dependent on any specific partner for its ecosystem to succeed. The more original equipment manufacturers (OEMs) and chip fabricators, for example, that join the ecosystem, the better. But if one specific potential partner refuses to join the party, even a large and powerful one, the ecosystem can still thrive. In ARM’s ecosystem this was in fact the case: for many years Intel refused to join and instead sought to promote its own, competing proprietary technology. When the ecosystem became the de facto global standard, Intel eventually joined as a partner.
The converse scenario is where you can provide a significant, but not critical, contribution to the ecosystem and are also highly dependent on a specific partner to complete the value proposition. Here it makes sense to participate as a follower in the ecosystem and seek to maximize the benefits you draw from it under the leadership of someone else. This is the case for the myriad of partners in Alibaba’s ecosystem. Even those that are huge and powerful companies in their own right are dwarfed by the massively greater scale of the ecosystem as a whole and need to accept Alibaba’s leadership as the pivotal player.
The two other scenarios demand compromise strategies. If you can potentially play a key role enabling the ecosystem to deliver potential value, but to do so you must also depend on another specific partner, then a struggle for leadership is likely to ensue. Here you find yourself in the realm of “co-opetition” seeking to lead the ecosystem when you can, but cooperating with initiatives that the other powerful partner takes. This is likely to be an uncomfortable position. As we will see, ecosystems tend to be most successful where one company acts as clear ecosystem leader, nurturing and strengthening the ecosystem as well as pursuing its own interests. Co-opetiton may, however, be a necessary fallback if you are unable to adjust the business model to reduce your dependence on a specific partner and assert your own leadership of the ecosystem.
Finally, if you are in a situation where your potential contribution and significance to the ecosystem is low and your engagement is not heavily dependent on a specific partner, then purely transactional engagement with the ecosystem, taking advantage of opportunities as and when they arise, is probably the right approach. In this case, the ecosystem is unlikely to contribute much to your success. Given the huge potential of ecosystem strategies to transform your business, this would be a lost opportunity. We would encourage going back to first principles and rethinking how by taking leadership of a new and different ecosystem you could harness the power of potential partners to gain the ecosystem edge.
The Way Ahead
A key theme of what follows in the book is how ecosystem leaders can best harness the potential power of ecosystems to deliver levels of innovation, new value creation, and flexibility that far exceed what traditional supply networks, focused alliances, or trading platforms can ever hope to achieve. This book is about what forward-thinking companies can do: first to identify the ways in which their existing ecosystems can be extended and leveraged to enhance their own competitive advantage, and then, to lead and shape the evolution of this ecosystem over time in ways that underpin the growth and success of their businesses as well as their ecosystems.
In chapter 2, we will trace the roots of ecosystem advantage and understand why it is now a priority for companies to develop and lead ecosystems. We will show why ecosystems enable us to increase the speed of innovation, tap into fundamentally new sources of value, and provide the organic flexibility to respond to a complex world with lots of uncertainty and rapidly changing consumer demands.
Companies design and manage ecosystems to deliver value to a final customer.23 In chapter 3, we will explore the different kinds of value that ecosystem strategies can create. These range from new product bundles and customer solutions to more efficient business models and completely new industries. The opportunity to create new sources of value is the starting point for any successful ecosystem strategy. Because partners will need to contribute to create this new value, it is clear that additional value will have to be shared. By promoting co-learning and innovation, ecosystems can create massive new pools of value, providing more than enough to be shared around.
Ecosystems derive much of their vitality and success from network economies. Once an ecosystem is well established or becomes the dominant player in its market, new partners will flock to join, contributing to a spiral of success. But when a new ecosystem is in its infancy, partners will be leery of engaging and investing. In chapter 4, we focus on how an ecosystem leader can kick-start a new ecosystem and get the flywheel of success turning.
Once an ecosystem is up and running, the challenge is to grow it to the scale necessary to deliver profits. This is the topic discussed in chapter 5. Growth is about attracting new customers and new partners, but it also requires the ecosystem leader to help attract the right partners: those with the capabilities and knowledge the ecosystem needs to thrive. To attract the right partners, the ecosystem leader needs to establish an architecture for the ecosystem going forward where partners can find their niche. Wherever possible, it needs to resist the temptation to undermine its partners by encroaching on their territory. And it needs to find ways to encourage partners to invest in the growth of the ecosystem. By doing so, it can leverage others’ investments as well as its own, opening the way to generating increasing returns as the ecosystem scales up.
Even ecosystems that achieve scale can falter in the face of competition with better ideas and value propositions. The ranks of almost-forgotten firms who led ecosystems that atrophied, from Netscape through to Myspace and Symbian, is testimony to this risk. For an ecosystem to be sustainable in the long term, it needs to go on pulling in new knowledge, learning, and innovating. Chapter 6 shows what lead companies can do to create the conditions for continuous learning and innovation in the ecosystem.
The kind of ecosystems many of tomorrow’s companies need to build to cope with disruption may never be as efficient as classic supply chains, focused alliances or trading platforms for delivering highly specified products, services, and tasks. The co-learning, innovation, and flexibility that ecosystems offer usually come at a cost in terms of lower efficiency and higher transaction costs. Ecosystem leaders therefore need to think carefully about what they can do to reduce this relative disadvantage, by making the interactions within their ecosystem as efficient as possible and enhancing the system’s overall productivity. This is the topic of chapter 7.
Ecosystems, of course, also need to make money for the ecosystem leader (as well as its partners). Value needs to be created, and captured. Chapter 8 focuses on the different ways that a vibrant ecosystem can be monetized while ensuring that the process remains fair to those who jointly create its success.
We then turn to the question of how your personal leadership style and the structure of your own organization will need to change in order to successfully lead an ecosystem. It is clear that one of the key advantages of ecosystems, compared with vertically integrated firms or joint ventures, is their flexibility. Ecosystems are dynamic organisms that can continually change with changing market conditions. Partners come and go and the configuration of the ecosystem can continually adapt. Self-organization often plays a big role, but the ecosystem leader can also help create the conditions for the ecosystem to adapt when it needs to. As was illustrated by the influence of Jack Ma at Alibaba, this requires a different type of personal leadership: one that looks beyond your own organization to the broader network on which your success depends. Among other factors, the senior management team of a company that wants to lead an ecosystem requires better collaborative skills and a higher tolerance for ambiguity and uncertainty than those running a more integrated firm or a well-honed supply chain. It also necessitates a restructuring of your company’s internal organization. New roles will need to be created, new performance measures implemented, and employees will need to be equipped to operate comfortably in a world of “co-opetition”. The characteristics of successful ecosystem leaders and the necessary changes to your internal organization are discussed in chapter 9.
Chapter 10, the concluding chapter, looks at the future of ecosystem strategies and their role in addressing an ever more volatile and uncertain world. At some point in time, your ecosystem may require restructuring, or may have outlived its usefulness. As partners’ roles become more stable and the market matures, there may be less need for flexibility and adaptation. The higher costs of coordination and potential for redundancies inherent in a dynamic ecosystem may then be less justified. Ultimately, therefore, it may make sense to transform the ecosystem into something closer to a traditional supply chain, create a joint venture with key ecosystem partners, or acquire key partners to reap the cost efficiencies offered by closer vertical integration.
You may then need to spawn a new ecosystem in adjacent markets or underpin a new business model. For example, as its e-commerce ecosystem matured, Amazon led the growth of a new Amazon Web Services (AWS) ecosystem alongside, which provided on-demand cloud computing platforms to individuals, companies, and governments on a paid subscription basis. It is now investing managerial effort and money in catalyzing a new mobility ecosystem with self-driving vehicles at its core. Similarly, ARM is striving to replicate the success of its ecosystems for mobile phones and servers in the rapidly emerging arena of the Internet of Things.
We will use a diverse set of cases to illustrate our concepts. All of what we write is based on published materials or insights from our interviews. The risk with case studies is of course that they capture a snapshot of a particular moment or a phase in a company’s evolution. But the competitive environment is dynamic and by the time you read this book, there will no doubt already be changes in what these companies do. For example, when the original case on ARM was written, it was an independent company. By the time we wrote this text, Softbank had acquired the company, and their ecosystem continues to evolve. Thomson Reuters spun off the division that we describe as Refinitiv in 2018. It was acquired by the London Stock Exchange in August 2019 for US$27 billion. Keep this in mind when interpreting the cases, looking for lessons that can help shape your own strategy, rather than silver bullets.