10

Looking Back, Looking Forward

The Power and the Potential of Ecosystems

WE ARE CONVINCED THAT IN THE FUTURE, HOWEVER UNPREDICTABLE it may be, all three trends that have come together since the early 2000s to make ecosystem strategy attractive today, are only likely to become more powerful. Customers, be they in consumer or business-to-business markets, will continue to shift to demanding solutions that no one single company has the capability to provide. As data and knowledge become more widely available, an increasing number of industries will face commoditization, so the pace of learning and innovation will become decisive for survival. And opportunities to connect and collaborate anywhere in the world will expand as information and communications technologies continue to improve. It is therefore a central thesis of this book that building ecosystems, rather than supply chains, will gain ground as a way of arranging competitive formations.1 As a corollary, ecosystems will increasingly go head-to-head in tomorrow’s markets.

Competition between Ecosystems Will Become the Norm

It is already happening. The AWS ecosystem is fighting for leadership of the fast-growing cloud computing market, with competing ecosystems led by Microsoft, Google, IBM, and Verizon. Another case in point is Amazon’s emerging ecosystem for autonomous delivery that seeks to pioneer the use of drones for package delivery and self-driving food-delivery vehicles that are being developed in partnership with Toyota, Pizza Hut, Uber Technologies, Mazda, and China’s Didi Chuxing, among others. This has taken on rival ecosystems led by Google’s parent, Alphabet, and others including Waymo, nuTonomy, and Lyft. It also faces Baidu, China’s largest search engine, which has built the Apollo ecosystem that has over ninety partners including Udacity, Microsoft, Infineon, TomTom, Daimler, Ford, and Volvo.2

In the coming era of extreme competition between ecosystems, it is not only customers who will enjoy more choice. Potential partners increasingly have a choice about which ecosystem they should join. Some may be in the fortunate position of being able to straddle competing ecosystems, placing a bet on more than one horse. That’s often difficult, though. If a partner is to invest in and integrate into an ecosystem, in order to benefit from the opportunities for shared learning and innovation that will result, it will need to choose a single ecosystem to align with.

The rise of ecosystems will also rewrite the rules of competition and strategy as we have come to know them, encapsulated in the seminal work of Michael Porter.³ The classic cost-leadership strategy based on growing the volume of products and services a company produces to reap economies of scale that drive down costs below competitors, will be replaced. In a world of competing ecosystems, cost advantage will come from aggregating the scale of your entire partner network to spread the fixed costs of investments in everything from design and innovation through to production and distribution. Your ability to reap network economies will become decisive. Witness the cost leadership that ARM achieves when it designs and supplies RISC chip architectures that go into over 95 percent of every mobile phone sold on the globe.

The classic differentiation strategy, based today on how much a company spends on R&D, the productivity of its scientists and engineers, and the acuity of its marketing staff in building its individual brand, will also have to be rewritten. As we have seen, competing on innovation in a world of ecosystems is all about your ability to leverage learning generated right across the ecosystem to fuel your own innovation and facilitate innovation by your partners. The power of your own brand will still be important. But how well you harness the halo effect of your ecosystem partners’ strong brands will become critical, especially in the early stages of developing your ecosystem. Alibaba’s Tmall, for example, has a huge advantage given that it is able to borrow the brands of nearly a quarter of the world’s luxury brands that have official shop-windows on the platform. It is now moving to leverage this further by establishing Luxury Pavilion, a virtual app within Tmall, focused solely on luxury brands. To reinforce its aura of exclusivity, only those selected as VIP members will be able to access it.4

Porter’s traditional “focus” strategy meant targeting a narrow segment of the market and tailoring the offering to serving its needs to the exclusion of other segments.⁵ This involved streamlining the offering to the unique features that segment was prepared to pay for, or pruning the product range back to include only those products that appealed especially to them. These moves would allow a company to differentiate itself by satisfying customers with unusual needs, or cut its costs. Ecosystem strategies, by contrast, enable you to achieve many of the advantages of focus while still appealing to a wide range of customers with different, and often complex, needs. This is because, while you stay focused, you can rely on a diverse set of partners to serve the needs of different customer segments with tailored offerings that dovetail with your own core contribution. The fact that partners have complementary capabilities and experience, combined with network economies, enables the ecosystem to offer a wide range of tailored offerings while still keeping costs down.

More recently, many companies have sought to combine classic competitive strategies with increased agility. Management literature is replete with advice on how this can be achieved, with suggestions ranging from change management programs through to the creation of ambidextrous organizations.⁶ Ecosystem competition, however, calls for a very different perspective on agility. Flexibility comes, in large part, from the fact that ecosystems are capable of self-organization, as partners adapt and evolve their strategies out of self-interest as the environment changes, much as do buyers and sellers in a market. Rather than simply struggling to make their own organizations more agile, ecosystems leaders take advantage of the capability of their ecosystem for self-organization to enable offerings to customers, as well as the value network behind it, to become more fluid.

Exhibit 10.1 summarizes the above considerations.

As competition between ecosystems grows, rewriting the rules of competition in the process, the demands on ecosystem leaders are only set to increase. The pressure to discover new sources of value for customers and to craft unique and attractive offerings will intensify. Partners will evaluate whether joining an ecosystem can deliver benefits, as well as how one ecosystem’s value proposition compares with that of another network. A potential ecosystem leader’s value proposition to partners will need to be top-notch. In the competition between ecosystems, the speed with which a leader kick-starts a virtuous spiral of cooperation and the rate at which it can scale its ecosystem are both critical. Those that get ahead because of network economies will surge forward in what could easily become a winner-take-all game. However, to sustain the ecosystem leader’s competitive position, the amount of learning and innovation generated by the ecosystem, and its ability to capture that learning, will be critical. Ecosystems that are less productive and efficient will be unable to compete. Mastering the strategies and capabilities we described earlier will become even more essential tomorrow than they are today.

EXHIBIT 10.1. Ecosystem Strategies Are Rewriting the Rules of Competition. Source: authors’ research.

When catalyzing the development of ecosystems, however, business leaders must bear in mind that ecosystems continually evolve, following a natural cycle of evolution that must be carefully anticipated and managed.

Riding the Wave of Ecosystem Evolution

Most ecosystems go through three stages. At first, the ecosystem leader identifies an opportunity and attracts lead partners and customers, kick-starting the virtuous cycle by which the ecosystem can discover new sources of value that it can deliver to customers. In the second stage, the ecosystem will start to scale, with new partners and customers joining the network. Different capabilities will be brought together in new ways, and exchanges of knowledge, experimentation, co-learning, and innovation will reach their peak. In the third stage, the different roles in the business ecosystem will become clearer. Partners will begin to specialize in activities or niches, and the interfaces and information flows between partners will become more formalized. That’s when the quest for greater efficiency will become a priority, with innovation in the ecosystem likely to taper off. The most successful partners in the ecosystem will start winning market share and influence from less successful ones, and gradually go on to dominate their niches.

Throughout that cycle, the ecosystem leader’s priorities and investment priorities, will need to change. In stage one, the focus will be on attracting partners, working with potential customers, recruiting and supporting market-makers, and encouraging partners to develop complementary products and services. In stage two, the ecosystem leader must provide a road map that will help the network scale, facilitate connections and knowledge exchange between partners, invest to encourage innovation, and set about developing a governance process.

As the ecosystem advances to stage three, the ecosystem leader will arrive at a critical point. An ecosystem’s advantages as a way of organizing a competitive formation may begin to fade when partners’ roles become more stable, the interfaces between them become more structured, dominant technologies and architectures emerge, and the market matures. All that will reduce the need for flexibility and adaptation. The ecosystem could persist. But in stable environments with little uncertainty and only incremental innovation, ecosystems are less efficient than supply chains. So, it may well make sense for the ecosystem leader to turn the network into a traditional supply chain, create a joint venture with key ecosystem partners, or acquire as many of its partners as it deems necessary to create a vertically integrated organization.

Moving toward a Traditional Supply Chain

Once the roles and responsibilities for activities in the ecosystem become clear, and specialized partners emerge in each of them, moving toward a traditional supply chain may make coordination more efficient. The way the traditional e-commerce business of Amazon has developed provides an interesting example of what happens. Uncertainty is reduced and supply contracts and service level agreements (SLAs) can be put in place to ensure that partners perform. This has the added advantage that it reduces the risk of freeloading that’s inherent in the relationship between the partners in an ecosystem. Information exchange processes between partners can be formalized, allowing the deployment of a seamless IT system to monitor and coordinate the chain of activities required to deliver products or solutions to customers. Introducing demand planning systems and capacity coordination along supply chains will iron out unnecessary bottlenecks and reduce uncertainty.

All those structures and processes would not have been suitable to support the development of the ecosystem during the first two stages of its lifecycle. With the entry of new partners altering roles and relationships, contractual relationships would have been impractical. Given the ever-changing flows of information and knowledge that are generated during the co-innovation process, standardized interfaces and hard-wired IT systems would have acted as straitjackets. However, when the ecosystem has matured, and its optimal structure becomes clear, formalizing relationships and introducing standard procedures and repeatable processes will enable significant efficiency gains. The ecosystem leader may decide, therefore, that the time is right to transition the ecosystem, or at least major parts of it, to a classic supply chain.

Redefining relationships with ecosystem partners to approximate more closely a traditional supply chain requires careful transition management. Three issues, in particular, must be addressed. First, the ecosystem leader as well as its partners must accept the redefinition. Ideally, redefinition should be by mutual agreement, with all the parties in the ecosystem understanding and accepting that the new relationship is a better arrangement.

Second, as in any major change process, key personnel have to support the new arrangement. That requires demonstrating that employees will not only have new roles, but also, that they will enjoy the opportunities for career development and higher rewards. Failure to do so will result in employees defecting from both the ecosystem leader and its partners, which will damage the business.

Third, the new relationship must respect the heritage of the ecosystem. During the emergence of the ecosystem, several promises would have been made and expectations created. The new competitive formation needs to respect those. Informal arrangements that have grown over time need to be restructured and formalized. The ownership of the intellectual property developed through co-innovation, for example, will need careful handling. Even the perceived lack of fairness, along with ambiguity and confusion, risks undermining relationships based on which products and services must be delivered to customer.

Converging on a Joint Venture

An alternative approach for the ecosystem leader is to consolidate the key partner relationships into a joint venture that will operate at the core of the network. Forming a joint venture to integrate loose relationships can offer more benefits than forming a traditional supply chain. A joint venture binds all the parties tightly together into a long-term relationship. That reduces the risk of key partners defecting to a competing ecosystem. Likewise, entering into a joint venture is a chance to negotiate exclusivity, ensuring that key partners don’t work with rivals.

A joint venture is better than a supply chain at handling contingencies for which it is difficult to specify a contract or SLA. When it is unclear, for example, what each party will contribute to the relationship in the future or how performance metrics will need to change, joint ventures offer a way to side-step those contingencies. In its essence, a joint venture agreement can be characterized by the statement that the parties share a common, well-defined goal, will do their best to contribute to the achievement of that goal, and will share the resulting profits. Unlike the early stages of an ecosystem, when the goals are less clear because of the need to discover new value, this approach is effective once the ecosystem has matured.

However, transforming the key partner relationships in a mature ecosystem into a joint venture has one major downside: it becomes difficult to replace a partner with an alternative collaborator, should the need arise. Joint ventures are notoriously difficult to unwind or even restructure. If the needs of the business change such that one partner no longer feels it needs to rely on the others, they can quickly descend into acrimony. A negative spiral of commitment loss, decision-making paralysis, declining performance, and wasted managerial effort on tackling internal disputes can ensue. If there is a possibility that different partners may be needed, or existing partners’ relevance might decline in future, maintaining the ecosystem or moving it to become a supply chain is a better option.

Acquiring Your Partners

The last option that ecosystem leaders can consider for restructuring a mature ecosystem is to acquire some of its partners. To see this in action, let us return once more to the case of Dassault Systèmes and how they acquired CST, a software developer for the simulation of the behavior of electromagnetic equipment. In 2016, almost fifteen years after it began developing its ecosystem for multiphysics simulations, DS acquired one of its partners, the German company CST. Electromagnetism is an essential part of a multiphysics simulation for the development of smart and connected products, and IoT devices—from their complex design, to ensuring the performance, reliability, and safety of their interactions with their surrounding environment. In 2015, CST explained that it was merging with DS to understand better the changing trends in simulation technology. It went on to say that these trends had become more visible in recent years, and could be boiled down to just two key ones: “increased customer requirements for multi-physics capabilities, and efficient solutions covering the entire design flow.” The partnership had led to “a closer relationship between the two companies, along with a confirmation that DS and CST have similar cultures: a focus on delivering leading technology, robust solutions, and strong technical support to best ensure our customers’ own success. It became clear that joining forces was the natural next step.”7

After having been part of the DS ecosystem for fifteen years, CST seems to have concluded that the flexibility the ecosystem afforded was much less important. Customers’ value was now well defined, as was how it needed to interface with DS. Having learned through experience that their organizational cultures and management styles were compatible, DS and CST agreed to the acquisition rather than remaining separate entities. Offering to acquire CST made sense for DS because of ecosystem maturity. CST’s role in supporting DS’s product line was clear, while the interfaces with DS technology had become well defined. Tight integration and a close working relationship were required to deliver the benefits of cooperation. There was no need to retain the flexible engagement model that had applied when CST first became a partner.

DS’s experience illustrates why acquiring key partners may make sense for the leader of an ecosystem that has reached maturity. It makes it easier to control its strategy, and its future direction. Its investments in innovation can be better focused, and it is possible to learn more easily than when it was an independent partner. Integrating CST with DS’s systems and reporting brought more stability and predictability to the relationship.

Acquiring partners is also a way of ensuring that their products and services will no longer be available to competitors. Amazon’s acquisition of Kiva Systems is a case in point. Influenced by its desire to differentiate its logistics capabilities from those of its rivals, Amazon acquired Kiva, a maker of robots that serviced warehouses, in 2012. Many retailers such as The Gap, Staples, and Saks were also using Kiva’s robots. However, Amazon immediately snapped up Kiva’s relationships with those companies so that it could deploy Kiva’s technologies to build a competitive advantage for itself.8

A related reason for an acquisition is that the partner’s knowledge and capabilities could become critical to the ecosystem leader’s future. Alibaba’s acquisition of UCWeb, which developed China’s most popular smartphone web browser, illustrates this well. In 2009, Alibaba bought a small stake in UCWeb with the aim of creating ties with it. By the end 2013, Alibaba increased its stake in the company to 66 percent because it was becoming clear that mobile web browsing would be critical to attract and retain new e-commerce customers. In 2014, Alibaba bought 100 percent of UCWeb, and combined it with its own operations to form a new mobile technology division that would oversee Alibaba’s browser, mobile search, location-based services, mobile gaming, app store, and mobile reader operations. UCWeb’s capabilities had become so critical for Alibaba’s business that it felt it should integrate it more closely than the loose relationship that an ecosystem would allow.

However, before moving quickly to acquire ecosystem partners, an ecosystem leader must be careful not to unintentionally jettison the advantages of maintaining flexible relationships with them. Partners in an ecosystem can usually draw on resources and knowledge from other companies, often a larger parent company that may not be available once they are acquired. Partners might therefore be more agile and innovative when they are in an ecosystem than after they are integrated into the company’s structures and systems. An ecosystem allows companies to engage with, and benefit from, many more partners than it would be possible for them to acquire. Relationships are also more flexible in an ecosystem, with new partners free to join and existing ones allowed to leave. Ecosystem builders should be careful, therefore, not to undermine the advantages of having partners in their own networks by abandoning an ecosystem too early.

Spawning Your Next Ecosystem

Ecosystems will move through their lifecycle, and their advantages may be blunted as they mature, but that doesn’t mean they will stop generating profits. The danger is that as an ecosystem evolves, its ability to deliver rapid innovation and exponential growth will decline. In order to keep innovating, grabbing new opportunities, and growing, ecosystem builders need to be continually on the lookout for chances to spawn new ecosystems. These new ecosystems may provide ways of unlocking value for new or existing customers, pioneering new business models, or entering other businesses.

Many of the companies we studied have maintained the growth and vitality of their businesses by doing just that: stimulating the development of ecosystems that parallel the ones they first created. For instance, Amazon has expanded from a books ecosystem to an e-commerce ecosystem, a cloud-based computing ecosystem, and to an autonomous delivery solutions ecosystem. Each has leveraged assets and knowhow from an earlier ecosystem. Books paved the way for e-commerce, Amazon’s massive IT infrastructure for e-commerce spawned the idea of offering cloud-computing, and autonomous delivery services are an extension of its e-commerce operations. Although related, each required a new ecosystem to be developed. Therefore, the partners and relationships that underpin the AWS ecosystem are different from those with which Amazon engaged in building its e-commerce ecosystem. Likewise, Amazon’s quest to turn autonomous delivery into reality has forced it to engage with a completely new set of partners.

The pattern is similar at ARM. While its ecosystem supplying mobile phones is still growing, with an over 95 percent market share for RISC chip architectures in the market, the growth potential is limited. ARM perceives a huge opportunity for its products in the nascent market for the IoT. Targeting that will require the company to engage with partners it hasn’t worked with in the past, such as manufacturers of products ranging from thermostats and sensors to heavy machinery, as well as a range of service providers, from property managers to telecommunications companies and city governments.

When an existing ecosystem leader spawns a new ecosystem, it must recognize that it isn’t starting from ground zero. It can leverage much from its existing assets and relationships to data and experience. The process must start with applying the ecosystem leadership mind-set we discussed in chapter 9 to the new opportunity. That means focusing on the potential to create new value for customers, the conviction that no single company can unlock the value opportunity acting alone, learning how to attract, engage, and motivate people who are not employees, and concentrating on increasing the size of the value pie rather than focusing on how the benefits should be divided.

Then, companies must redeploy executives with experience in partner engagement and building the capabilities required to lead an ecosystem. Alibaba’s Jack Ma has an eye for spotting new opportunities, which is backed up by the company’s ability to count on managers with years of experience in catalyzing and scaling an ecosystem. Daniel Zhang, Alibaba’s CEO, and many of his team, have accumulated a deep understanding about leading ecosystems over nearly two decades.

As Alibaba’s CEO, Daniel Zhang, explained: “It would be wrong . . . to describe Alibaba as an e-commerce platform. The company’s core strength is becoming clear as it sucks up data through its mobile super-apps, which cover shopping, entertainment, finance, and social networking. We are positioning ourselves as a data company.” He adds, “We have half a billion customers with shopping intentions and a method to pay. We know who they are, what they want, what they hate. This data revolution has enabled Alibaba to create personal credit profiles, known as Sesame Scores, for most of its users. Such scores are based on indicators, for example, the intensity with which users shop online, pay their utility bills on time, have a stable residential status, and have been using the same mobile phone number for a long time. In turn, that has facilitated the development of unrelated new businesses, such as Mobike bicycle hire, which assumes that those with high Sesame Scores are trustworthy enough not to pay a deposit.”9

In fact, Alibaba has used its Sesame Scores to make it easier for partners to extend credit for everything from car loans to mobile-phone service contracts and a host of other types of consumer credit. That has enabled the company’s partners to open up the credit market to those who have little or no credit history at traditional credit agencies. When Alibaba wanted to create an ecosystem to provide credit to small businesses outside China, it partnered with the US peer-to-peer lender Lending Club and small business lending specialists Iwoca and Orange Money in the UK. It promoted their financial services on the e-credit section on Alibaba.com and the 1688.com B2B platform, supplied them with data on the trading activities of loan applicants, and helped them refine their risk models.

When the company entered China’s cloud computing market with Ali-Cloud, it targeted Taobao sellers that needed cloud capacity and trusted Alibaba, rather than trying to sell to users outside its network. When Alibaba was building a new ecosystem for financial services outside China, it ran into the entry barrier of Visa’s and Mastercard’s high customer penetration rates in the United States and Europe. It decided to focus on its existing customer base in China by enabling the use of Alipay for purchases, currency exchange, and tax refunds by the rapidly increasing numbers of Chinese traveling abroad (in 2016 more than 122 million Chinese ventured abroad).10 It initially entered into partnerships with duty free shops, airport operators, and even small stores in Asia’s night markets, who were keen to engage with relatively wealthy Chinese tourists. By opening doors to these new partners, Alibaba’s employees developed an understanding of what different parties wanted, and tested their models. It gradually recruited a wider range of partners to expand the ecosystem.

Likewise, the team that ARM charged with developing its new IoT ecosystem includes a host of veterans from its mobile phone ecosystem, who bring a diversity of experience to the new challenge.

Leveraging the company’s reputation as a dynamic, and yet fair, ecosystem leader can give it a head start when creating an adjacent ecosystem. How the ecosystem leader managed the first ecosystem will determine its credibility in future ecosystems. A commitment to maintaining the health of an ecosystem and the care ecosystem leaders take not to tread on partners’ toes, for example, will help them develop other ecosystems quickly. By contrast, a reputation for encroaching on partners’ territories or changing direction in ways that render obsolete partners’ investments will impede the ability to build new ecosystems. Intel, for example, has participated in open source communities since 1999, but it is sometimes criticized for a lack of commitment to nurturing its ecosystems. The company faced a barrage of complaints after the release of its Intel Pro/Wireless products in 2005 because it refused to grant free redistribution rights for the firmware that must be included in the operating system for wireless devices to function.¹¹ Some commentators labeled Intel “an Open Source fraud,” accusing it of favoring its biggest customer, Microsoft, over the ecosystem.¹² Whatever the truth is, the perceptions about Intel have not helped it create an ecosystem for mobile device chips, an area where it has struggled.

Companies that follow this growth path will be able to create a portfolio of ecosystems around each of their businesses. Each will be at a different stage of development: some will be trying to address a new opportunity, some will be trying to scale, and others will have reached a level of maturity. There will be no single operating model that will apply to all of them. The ecosystem leader’s task is to nurture the portfolio, ensuring that each ecosystem in its universe is managed by executives with the mind-sets, processes, tools, and styles that match the opportunity and the stage of its development. A key part of its role will also be to facilitate the transfer of assets, experience, and knowledge between the different ecosystems on which the company’s businesses depend.

A New Way of Doing Business

James Moore, who coined the term business ecosystem, spent a considerable amount of time in Central America, studying forests and ecology after a long and successful career at AT&T.13 That led him to write a book in 1996 entitled, The Death of Competition: Leadership and Strategy in the Age of Business Ecosystems.¹⁴ Competition hasn’t died. But Moore’s fundamental argument that companies fail because they focus on perfecting their capabilities, internal processes, and products and services, but fail to evolve with the changing external environment appears even more prescient today than it did two decades ago. The central theme of his book was that in order to have a successful business, the leaders of the organization must learn about, and lead, the external environment—the ecosystem of the organization—as well as get the fundamentals of the internal operations right. Most business failures result from the organization’s inability to “co-evolve” intelligently with its surrounding business and societal environment. He believed that too many executives focused their time primarily on day-to-day struggles with direct competitors. They worked “in” the business, rather than “on” the business. Instead, they needed to begin by redefining the nature of the value their company could offer to the customer, and then focus on orchestrating the contributions of a network of players under their leadership.

Moore saw a future where competitive formations went beyond multidivisional organizations and the workings of the invisible hand of the market. He believed that successful business leaders would need to lead not only their organizations, but also myriad partners. They would have to serve as catalysts, bringing together different capabilities from which new businesses, new not-for-profit organizations, new rules of competition and cooperation, and new industries would emerge.

Our aim has been to help you, the reader, succeed in that future, which is almost upon us. It is a world in which no company can succeed without harnessing the potential of different partners to help it access a broader range of capabilities, speed up its rate of learning and innovation, and achieve a level of flexibility impossible for even the most agile corporation. It is a world where leaders must go beyond setting their own strategies, beyond developing their own organizations, beyond responding to their current competitors, and embrace the challenge of reshaping their external environment.

Rather than taking the business environment as a given that CEOs only need to understand and respond to, competing will mean catalyzing the growth and development of a new environment in the future. To accept the ecosystem in which a company is embedded as the set of customers, suppliers, competitors, and regulators that interact with it is to surrender the potential of the world of diverse capabilities and knowledge beyond the boundaries of your company and your industry. Having read this book to its very end, we hope you will now be both equipped and motivated to grasp that challenge, and the future, with both hands.