08 Mar 2004  Research & Ideas

Creating Value in Your Business Ecosystem

The metaphors of keystones and ecology help you think about your business environment, say professor Marco Iansiti and consultant Roy Levien. A Harvard Business Review excerpt.

 

Wal-Mart's and Microsoft's dominance in modern business has been attributed to any number of factors, ranging from the vision and drive of their founders to the companies' aggressive competitive practices. But the performance of these two very different firms derives from something that is much larger than the companies themselves: the success of their respective business ecosystems. These loose networks—of suppliers, distributors, outsourcing firms, makers of related products or services, technology providers, and a host of other organizations—affect, and are affected by, the creation and delivery of a company's own offerings.

Like an individual species in a biological ecosystem, each member of a business ecosystem ultimately shares the fate of the network as a whole, regardless of that member's apparent strength. From their earliest days, Wal-Mart and Microsoft—unlike companies that focus primarily on their internal capabilities—have realized this and pursued strategies that not only aggressively further their own interests but also promote their ecosystems' overall health.

. . .

The keystone advantage

Keystone organizations play a crucial role in business ecosystems.

Fundamentally, they aim to improve the overall health of their ecosystems by providing a stable and predictable set of common assets—think of Wal-Mart's procurement system and Microsoft's Windows operating system and tools—that other organizations use to build their own offerings.

Despite Microsoft's pervasive impact, it remains only a small part of the computing ecosystem.

Keystones can increase ecosystem productivity by simplifying the complex task of connecting network participants to one another or by making the creation of new products by third parties more efficient. They can enhance ecosystem robustness by consistently incorporating technological innovations and by providing a reliable point of reference that helps participants respond to new and uncertain conditions. And they can encourage ecosystem niche creation by offering innovative technologies to a variety of third-party organizations. The keystone's importance to ecosystem health is such that, in many cases, its removal will lead to the catastrophic collapse of the entire system. For example, WorldCom's failure had negative repercussions for the entire ecosystem of suppliers of telecommunications equipment.

By continually trying to improve the ecosystem as a whole, keystones ensure their own survival and prosperity. They don't promote the health of others for altruistic reasons; they do it because it's a great strategy.

Keystones, in many ways, are in an advantageous position. As in biological ecosystems, keystones exercise a systemwide role despite being only a small part of their ecosystems' mass. Despite Microsoft's pervasive impact, for example, it remains only a small part of the computing ecosystem. Both its revenue and number of employees represent about 0.05 percent of the total figures for the ecosystem. Its market capitalization represents a larger portion of the ecosystem—typical for a keystone because of its powerful position—but it has never been higher than 0.4 percent. Even in the much smaller software ecosystem, in which the company plays an even more crucial role, Microsoft's market cap has typically ranged between 20 percent and 40 percent of the combined market cap of software providers. This is a fraction of the more than 80 percent of total market capitalization of the much larger ecosystem of computer software, components, systems, and services that IBM held during the 1960s.

Broadly speaking, an effective keystone strategy has two parts. The first is to create value within the ecosystem. Unless a keystone finds a way of doing this efficiently, it will fail to attract or retain members. The second part, as we have noted, is to share the value with other participants in the ecosystem. The keystone that fails to do this will find itself perhaps temporarily enriched but ultimately abandoned.

Keystones can create value for their ecosystems in numerous ways, but the first requirement usually involves the creation of a platform, an asset in the form of services, tools, or technologies that offers solutions to others in the ecosystem. The platform can be a physical asset, like the efficient manufacturing capabilities that Taiwan Semiconductor Manufacturing offers to those computer-chip design companies that don't have their own silicon-wafer foundries, or an intellectual asset, like the Windows software platform. Keystones leave the vast majority of value creation to others in the ecosystem, but what they do create is crucial to the community's survival.

The second requirement for keystones' success is that they share throughout the ecosystem much of the value they have created, balancing their generosity with the need to keep some of that value for themselves. Achieving this balance may not be as easy as it seems. Keystone organizations must make sure that the value of their platforms, divided by the cost of creating, maintaining, and sharing them, increases rapidly with the number of ecosystem members that use them. This allows keystone players to share the surplus with their communities. During the Internet boom, many businesses failed because, although the theoretical value of a keystone platform was increasing with the number of customers, the operating cost was rising, as well. Many B2B marketplaces, for example, continued to increase revenue despite decreasing and ultimately disappearing margins, which led to the collapse of their business models.

eBay shares the value it creates with members of its ecosystem.

A good example of a keystone company that effectively creates and shares value with its ecosystem is eBay. It creates value in a number of ways. It has developed state-of-the-art tools that increase the productivity of network members and encourage potential members to join the ecosystem. These tools include eBay's Seller's Assistant, which helps new sellers prepare professional-looking online listings, and its Turbo Lister service, which tracks and manages thousands of bulk listings on home computers. The company has also established and maintained performance standards that enhance the stability of the system. Buyers and sellers rate one another, providing rankings that bolster users' confidence in the system. Sellers with consistently good evaluations attain PowerSeller status; those with bad evaluations are excluded from future transactions.

Additionally, eBay shares the value that it creates with members of its ecosystem. It charges users only a moderate fee to coordinate their trading activities. Incentives such as the PowerSeller label reinforce standards for sellers that benefit the entire ecosystem. These performance standards also delegate much of the control of the network to users, diminishing the need for eBay to maintain expensive centralized monitoring and feedback systems. The company can charge commissions that are no higher than 7 percent of a given transaction—well below the typical 30 percent to 70 percent margins most retailers would charge. It is important to stress that eBay does this because it is good business. By sharing the value, it continues to expand its own healthy ecosystem—buyers and sellers now total more than 70 million—and thrive in a sustainable way.

Match Your Strategy to Your Environment

by Marco Iansiti and Roy Levien

A company's choice of ecosystem strategy—keystone, physical dominator, or niche—is governed primarily by the kind of company it is or aims to be. But the choice also can be affected by the business context in which it operates: the general level of turbulence and the complexity of its relationships with others in the ecosystem.

If your business faces rapid and constant change and, by leveraging the assets of other firms, can focus on a narrowly and clearly defined business segment, a niche strategy may be most appropriate. You can develop your own specialized expertise, which will differentiate you from competitors and, because of its simple focus, foster the unique capabilities and expertise you need to weather the turbulence of your environment.

If your business is at the center of a complex network of asset-sharing relationships and operates in a turbulent environment, a keystone strategy may be the most effective. By carefully managing the widely distributed assets your company relies on—in part by sharing with your business partners the wealth generated by those assets—you can capitalize on the entire ecosystem's ability to generate, because of its diversity, innovative responses to disruptions in the environment.

If your business relies on a complex network of external assets but operates in a mature industry, you may choose a physical dominator strategy. Because the environment is relatively stable and the innovation that comes with diversity isn't a high priority, you can move to directly control the assets your company needs, by acquiring your partners or otherwise taking over their functions. A physical dominator ultimately becomes its own ecosystem, absorbing the complex network of interdependencies that existed between distinct organizations, and is able to extract maximum short-term value from the assets it controls. When it reaches this end point, an ecosystem strategy is no longer relevant.

If, however, your business chooses to extract maximum value from a network of assets that you don't control—the value dominator strategy—you may end up starving and ultimately destroying the ecosystem of which you are a part. This makes the approach a fundamentally flawed strategy.

If you have a commodity business in a mature and stable environment and operate relatively independently of other organizations, an ecosystem strategy is irrelevant—although that may change sooner than you think.

About the authors

Marco Iansiti is the David Sarnoff Professor of Business Administration at Harvard Business School.

Roy Levien is the manager and a principal at Keystone Advantage, a technology consultancy in Lexington, Massachusetts. They are the authors of The Keystone Advantage: What the New Dynamics of Business Ecosystems Mean for Strategy, Innovation, and Sustainability (HBS Press, 2004).

Excerpted with permission from "Strategy as Ecology," Harvard Business Review, Vol. 82, No. 3, March 2004.

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