Guiding the Digital Transformation of Organizations [Part 1 – Digital Strategy, 2 ed.]

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Guiding the Digital Transformation of Organizations - Second Edition Vallabh Sambamurthy & Robert W. Zmud

Part 1. Digital Strategy

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Guiding the Digital Transformation of Organizations Part 1. Digital Strategy By Vallabh Sambamurthy and Robert W. Zmud Second Edition Copyright © 2017 First Edition Copyright © 2012 All rights reserved. No part of this publication shall be reproduced, distributed, or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information retrieval system without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission requests, email the publisher at: [email protected].

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TABLE OF CONTENTS PART 1. DIGITAL STRATEGY Chapter 1

Digital Innovation and Disruption……………………………………………

2

Chapter 2

Digital Strategy Fundamentals……………………………………………….

26

Chapter 3

Digitalized Business Models for Pipeline Ecosystems…………….

44

Chapter 4

Digital Strategy Formulation for Pipeline Organizations…………

70

Chapter 5

Digital Strategy and the External Sourcing of Capabilities…….

102

Chapter 6

Digitalized Business Models for Network Ecosystems…………….

123

Chapter 7

Digital Strategy Formulation for Network Organizations……….

150

Chapter 8

Grappling with the Risks of Digitalization……………………………….

177

Chapter 9

Executive Mandates: Digital Strategy………………………………………

206

Glossary

…………………………………………………………………………………………………..

537

Chapter 1. Digital Innovation and Disruption

Today there are clear signs of intense, continuous and unprecedented waves of economic competition. Traditional industries are being disrupted by the arrival of new firms and, more significant, the emergence of new industries offering novel ways of fulfilling customer needs and desires. Firms that were household names at the turn of the century (Walmart, Sears, Cisco, and Dell) are now replaced with new firms (Facebook, Apple, Google1 and Tesla). Since 1983, Fortune magazine has published an annual ranking of the most admired companies. Though methodology and criteria have varied somewhat over the years, the overall process has remained remarkably consistent. For the 2016 list, these criteria involved assessments of a candidate firm’s: ability to attract and retain talented people, quality of management, social responsibility, innovativeness, product/service quality, use of corporate assets, financial health, long-term investment value, and effectiveness in doing business globally.2 Table 1-1 provides a ranking of the top-ranked most admired companies from 1983 to 2016. In compiling this listing, three-year intervals and companies’ average rank in the annual top-ten of most admired companies were used. Note two key insights. First, a number of companies have multiple appearances, suggesting that these companies were steered by especially-strong leadership teams able to unravel

Google is actually one of the business units within Alphabet, a multinational holding company formed in 2015 by Google’s founders. The more familiar name of Google is used throughout this book. 2 For more information, see: http://www.kornferry.com/institute/fortune-worldsmost-admired-companies#sthash.TqIusyvP.dpuf 1

2

their firms’ competitive situations, formulate effective business strategies, and successfully implement these strategies. Not surprisingly, the stocks of these mostadmired companies have proven to be extremely good investments.3 Second, there are two points of major discontinuity in the table: the first appearing in the latteryears of the 1990s, and the second in the latter-years of the 2000s.

These two

points-of-discontinuity reflect two substantive business disruptions. Table 1-1 Most Admired Companies: 1983-2016

Years

Rank 1

2

3

4

5

2014-2016

Apple

Google

Amazon

2011-2013

Apple

Google

Amazon

Coca Cola

Berkshire Hathaway

2008-2010

Apple

Google

Berkshire Hathaway

Toyota Motors

Johnson & Johnson

2005-2007

General Electric

Starbucks

Southwest Airlines

FedEx

Berkshire Hathaway

2002-2004

Walmart

Southwest Airlines

General Electric

Berkshire Hathaway

Microsoft

1999-2001

General Electric

Microsoft

Walmart

1996-1998

Coca Cola

Microsoft

Intel

Berkshire

Hathawaya

Walt Disney

Cisco Systems Dell Southwest Airlines Merck 3M Microsoft

Johnson & Johnson

1993-1995

Rubbermaid

Coca Cola

1990-1992

Merck

Rubbermaid

Walmart

Proctor & Gamble

PepsiCo

1987-1989

Merck

Rubbermaid

Liz Claiborne

3M

Boeing Phillip Morris

1983-1986

IBM

Dow Jones

HP

Merck

Coca Cola

Home Depot

Berkshire Hathaway is a multinational conglomerate that wholly owns a number of companies (e.g., GEICO, BNSF, Fruit of the Loom, Helzberg Diamonds, Duracell, and McLain Trucking, among others) and enjoys substantial holdngs of other companies (e.g., Johnson and Johnson, Coca Cola, IBM, and American Express, among others). a

Significant business disruptions occur when an industry’s incumbents face one or more challengers whose business models offer far greater value to customers than the incumbents’ business models and these incumbents are unable to effectively respond to the ensuing competitive threat. A key element in this definition is that of

J. Anderson and G. Smith, “A Great Company Can Be a Great investment,” Financial Analysts Journal, July/August 2006, pp. 86-93). 3

3

a business model – a simplified and aggregated conceptualization of the valuecreating, profitability-sustaining activities of an organization.

Importantly, not all

business innovations are disruptive. A business innovation that is compatible with an industry’s established business models generally creates short-term benefits (i.e., revenue and profitability gains) for the innovating firm, and long-term benefits (i.e., the exposure of previously-uncontested competitive niches) for all incumbents. The two points-of-discontinuity noted above in Table 1-1 reflect periods of digital disruption, where (1) incumbents in existing industries faced overwhelming competitive challenges, and (2) entirely new industries (e.g., Internet sales channel, Internet search) were created. Two forces explain much of this digital disruption: unceasing advances in digital technologies and globalization. Digital technologies refer to the many technologies (encompassing hardware, software and, most often, sophisticated combinations of hardware and software) involved in specifying, capturing, processing, storing and transmitting data. Here, data refers to attributes of objects or events represented in digital (discrete sets of ones and zeroes) form. (especially

those

associated

Through hardware and software innovations with

microprocessor

miniaturization),

digital

technologies have experienced sustained, exponential growth in performance relative to cost. Popularly referred to as Moore’s Law, the capability per dollar of digital technologies essentially doubles each year – enabling an unending stream of new technological possibilities.

Importantly, these technological innovations yield new

digitally-enabled, value-creating functionalities (e.g., Amazon’s digital ordering process and fulfillment processes), which can be creatively recombined to produce new functionalities (e.g., Amazon’s 1-Click ordering process), and so on. It is the 4

confluence of such streams of innovative functionalities that periodically drive truly substantive business disruptions. Today, five technologies represent the tip of the spear of digital disruption – social, mobile, analytics, cloud, and the Internet of Things. Globalization refers to a process of interaction and, especially, integration among the people, companies and governments of different nations.

The

extraordinary advances in digital technologies have broken through well-established barriers of space and time, ushering in a largely irreversible globalization of business characterized by vast streams of data (and information) endlessly moving around the world. As a consequence, firms are rethinking what it means to be global. Digitally-enabled globalization is requiring established companies to reinvent themselves in order to: leverage global capabilities, present a common face to global customers, and compete with digital startups. Prime examples of such globalized firms are those providing logistics services (UPS and DHL) and technology services (IBM and Infosys).

As economic activity accommodates emerging markets and

refocuses on local communities, new competitive spaces arise – such as firms focused on meeting consumers’ localized needs regarding travel information (TripAdvisor and Feefo), temporary asset use (Airbnb and Zipcar), and personalized services (Uber and TaskRabbit). In essence, the mind-set that digital technologies primarily represent a productivity-enhancing tool is being replaced with a new mindset that recognizes digital technologies as a platform for strategic innovation, transformation and disruption. Consider, for example, the fintech revolution – the disruptions currently

5

affecting financial services.4,5 The business models of retail banks have traditionally sought to meet all of their customers’ financial needs.

Here, low-cost checking

accounts serve as ‘loss leaders’ to earn attractive margins in other areas (e.g., home mortgages, car loans, credit cards, investment management, etc.). Recently, new entrants to the financial services industry seek to exploit technological advances along with shifts in consumer behavior gravitating toward self-service and digitally-enabled transaction channels. They are finding success in weakening and dismantling the relationships that retail banks have developed over the years with their customers. Typically, these challengers (startups, established digital banks, and established firms holding strong, broad-based digital capabilities) target the more-profitable segments of retail banking, making it clear that they have little interest (at least for now) in handling all of a person’s banking needs. The people most attracted to these fintech challengers are millennials, small businesses, and the underbanked – retail banking customer segments particularly sensitive to costs and to the enhanced consumer experience provided through digital transaction channels. The first wave of the fintech revolution focused on payment transactions (e.g., PayPal and Square), which represents about six percent of global banking transactions. The next waves seem to be converging on retail lending (roughly twelve percent of global

banking transactions, e.g.,

Affirm

and

SoFi)

and retail

savings/investment (roughly fifteen percent, e.g., CircleUp and Loyal3).

These

G. Bacso, M. Dietz and M. Radnai, “Decoding Financial-Technology Innovation,” McKinsey Quarterly, Number 2, 2015, pp. 26-27). 5 M. Dietz, P. Härle and S. Khanna, “A Digital Crack in Banking’s Business Model,” McKinsey Quarterly, Number 2, 2016, pp. 50-53. 4

6

disruptive business innovations improve on how incumbent retail banks do business and are ripe for imitation. Taken together, these financial services innovations are forcing a reinvention of what it means to be a retail bank. Most of today’s fintechs, which number in the thousands globally, remain under the regulatory radar but are quickly attracting attention as they reach meaningful scale. Why all this entrepreneurial activity? Simply put, the potential rewards are enormous. Capturing just a tiny slice of the $1 trillion global retail banking market can deliver very attractive returns for owners and investors. This ongoing disruption of the financial services industry is not an isolated exception.

Digital competitors are entering all industries, creating a need for

strategic responses by established businesses and by the early new entrants. At the same time, an organization’s digitally-enabled operational business processes have become mission critical.

There is no room for operational errors, even as

organizations strive to increase their pace of digital innovation. The objective of this book is to depict how today’s exemplar organizations set and evolve their digitally-enabled business strategies, or stated more directly – their digital strategies. In this chapter, we begin this conversation by introducing three key notions: 

The Evolving Nature of Markets and Firms



Three Eras of Digital Disruption



The Evolving Landscapes of Industries

The Evolving Nature of Markets and Firms Markets and firms are historically regarded as significant mechanisms for the organization of economic activities.

Economic exchanges in a market occurs 7

primarily through pricing mechanisms and contractual mechanisms, whereas economic exchanges within a firm occurs primarily through hierarchical structures and control structures. Discrete market exchanges can occur between two people (C2C, or consumer-to-consumer), two organizations (B2B, or business-tobusiness) or between an organization and a person (B2C, or business-toconsumer). Successful markets bring two parties together such that each party is confident that the exchange will be evenhanded; that is, one party, the consumer, receives a sought value-unit at a fair price and the other party, the producer, receives fair compensation for delivering this value-unit to the consumer. Successful markets are characterized by three key attributes: 

Demand exists for the value-units being exchanged.



The market is profitable.



The market is efficient.

An efficient market exists when maximal opportunities are provided to producers and consumers to effect transactions with minimal transaction costs.

Inefficient

markets are susceptible to market failure, with four conditions explaining a preponderance of market failures: 

One or both parties hold incomplete information about the market, e.g., existence of alternative buyers/sellers, knowledge of the other party and this party’s history of performance, goods/services quality, production costs, availability of substitute goods/services, etc.



One or both parties are exposed to excessive risk, i.e., trust mechanisms are lacking or are of inferior quality.



One or more third-parties not directly involved in an exchange or in facilitating the exchange benefit from the exchange, e.g., a ‘kickback’.



One of the parties holds undue influence, e.g., monopoly power or huge size, and dictates the parameters of the exchange to the detriment of the 8

other party. When one or more of these conditions are present, the likelihood of market participation decreases and the likelihood of participant dissatisfaction increases. As the value-units being exchanged increased in complexity and sophistication as a result of the first (specialized machinery and economies of scale) and second (railroads and telecommunication) industrial revolutions, firms emerged as an alternative to markets. Viewed simply, a firm (or, an organization) consists of a set of operating units coordinated and integrated by a hierarchy of managers, supported by other employees – all of which are located within an overarching organizational structure.

Each operating unit itself has managers and workers

engaged in specialized economic activities. And, the firm as a whole interacts with customers and suppliers within a market-focused ecosystem that, typically, engages multiple markets for goods and services. Today, the distinctions between markets and firms are blurred via the emergence of two distinctive, market-focused ecosystems: the pipeline ecosystem and the network ecosystem. With the pipeline ecosystem (the dominant ecosystem over the last century; depicted as Figure 1-1), a producer organization targets a collection of value-units at one or more consumer segments and fashions a linear value stream involving numerous upstream (e.g., raw material suppliers, component suppliers, etc.), midstream (e.g., producers) and downstream (e.g., distributors, retailers, etc.) organizations to deliver the value-units to consumers. This ecosystem is referred to as a linear value stream because it involves a sequence of value-adding steps: raw materials are assembled first into components and then into finished value-units 9

(information, a good or a service) that are delivered to consumers, either through a complex downstream process facilitated by intermediaries or through a simpler, direct-to-consumer downstream process.

These value-stream steps are often

performed by different organizations (exploiting specialization), but may all be performed by the producer; such a producer is referred to as being fully verticallyintegrated. Figure 1-1 The Pipeline Ecosystem Upstream Material & Component Suppliers

Midstream

Intermediaries

Producer

Downstream

Intermediaries

Consumers

Markets Markets

The producer organization in a pipeline ecosystem has: 

Full authority for determining the targeted consumers and the nature of the value-units being offered to these consumers.



Full authority for fashioning and overseeing the linear value stream.



Full ownership of the assets used in assembling the finished value-units, as well as the assets used in any vertically-integrated portions of the linear value chain.

10

The primary market defining a pipeline ecosystem is that between the producer and the consumer. individual.

In a B2C pipeline ecosystem, the predominant consumer is an

In a B2B pipeline ecosystem, the predominant consumer is an

organization. In addition, a variety of secondary markets (usually B2B markets for raw materials, for component parts, for products to stock a retail store, etc.) are associated with pipeline ecosystems. With the network ecosystem (an ecosystem that has become increasingly visible over the last decade; depicted as Figure 1-2), a network of value-unit producers and value-unit consumers are brought together by a network orchestrator. The primary market defining a network ecosystem involves value-unit exchanges between producers and consumers.

The network orchestrator creates and

manages the market environment and the transaction environment within which these value-unit exchanges occur.

Importantly, the network orchestrator neither

determines the nature of the value-units being exchanged nor owns any of the assets involved in producing these value-units.

11

Figure 1-2 The Network Ecosystem Upstream Material & Component Suppliers

Midstream Producer Network

Intermediaries

Markets

Downstream Network Orchestrator

Consumer Network

Markets

Market

What is the difference between a retailer, such as Walmart, and a network orchestrator, such as eBay? Doesn’t Walmart create a market environment (a retail store with a finely curated stock of products) within which producers and consumers are brought together? The difference is that: 

Walmart determines which specific products are stocked in each retail store, takes ownership of these products once they have left the manufacturer, has fashioned very sophisticated linear value streams to bring these products to their stores, and owns many of the logistical assets used in these value streams.



eBay does not determine the nature of the products to be sold by the producers using eBay’s market environment, never takes ownership of these products, and has no responsibility for nor owns any of the assets deployed to produce these products or to transfer ownership of the products from producers to consumers.

As a consequence, Walmart represents a pipeline organization, whereas eBay represents a network organization. 12

Digital disruption is having profound effects on the roles that humans serve in market-focused ecosystems, especially as employees of participating organizations. Digital technologies and humans differ markedly in the types of work tasks each best handles, and Table 1-2 suggests the probability of different types of work tasks being performed digitally rather than being performed by humans. Table 1-2 Probability of Work Tasks Being Performed Digitally Type of Work Learning

Definition Acquiring new knowledge by interpreting & integrating captured data and experiences

Situational Awareness

Interpreting environmental & situational cues

Word/Image Analysis

Interpreting the meaning of words (textual & audio) and images (sketches, photos & video)

Numerical Analysis

Probability Lower

Performing complex algorithmic operations

Repetitive Programming robot-like digitalized solutions to Physical Activity carry-out simple & complex physical tasks Repetitive Programming software to carry-out simple & Data Processing complex data processing tasks

Higher

Digital solutions are especially good for executing pre-specified rules, but not as effective at pattern recognition, complex communication, and creativity – types of activities that well-informed, talented humans can be exceptional at performing. For example, think about how important it is during a brainstorming session to quickly filter out bad ideas, but recognize and enhance the good ideas. It is hard to conceive that a digital solution could outperform a human with such a work task. Still, the relentless advances in digital technologies are making significant headway with the digital enablement of work tasks requiring considerable levels of situational understanding and prediction. Perhaps the best that can be said for now is that the 13

roles served by digital technologies and by humans in innovative business models are in flux and will certainly continue to evolve in the future. Three Eras of Digital Disruption Figure 1-3 presents timelines for three eras of digital disruption. These eras reflect the

influence of increasing digitization and

increasing digitalization.

Digitization refers to the purely technical processes associated with converting sensed and captured data into binary form, storing and transmitting these binary data, manipulating these data, and storing/transmitting the outcomes of these data manipulations. Digitalization, on the other hand, refers to more complex processes of applying digitization within organizations and within the social and economic contexts within which organizations are embedded – thence producing changes (often incremental, but occasionally radical and disruptive) to these organizations and to their social and economic contexts. Figure 1-3 Three Eras of Digital Disruption 1950

1960

1970

1980

1990

2000

2010

2200

Data Processing & Proprietary Connectivity

Era 1

Coordination & Open Connectivity

Era 2 Mobility & Ubiquitous Connectivity

Era 3

14

The start date for each of the three eras is, at best, an approximation. While it is fairly easy to identify when a specific digital technology first appeared, it is very difficult to identify when novel instances of digitalization are applied by earlyadopters.

Early-adopters refer to organizations whose leadership teams are

regularly among the first to apply new forms of digitalization. It takes time for earlyadopters to learn about and expose the usefulness of new forms of digitalization and for these exposed uses to take root across organizations, industries and societies. While some early-adopters may experience huge competitive gains from their innovative actions, a greater number experience little gain or suffer losses because innovative actions tend to be costly and often prove to be ill-founded or ill-timed. It is important to note that the lapse in time between the start of an era and when implementations of new forms of digitalization consistently yield significant value for adopters shortened considerably between the first and second eras, and is expected to shorten even further between the second and third eras. There are a number of possible explanations as to why this is the case, and these will be raised throughout this book.

One of these reasons is that the forms of digitalization

emerging in one era, e.g., Era 1, become pervasively adopted over time and are continuously enhanced, thus providing an ever-expanding digitalization foundation that is leveraged as newer forms of digitalization emerge in succeeding eras, e.g., Eras 2 and 3. New forms of digitalization are rendered through four engines of digitalization (i.e., automation, control, empowerment and interaction), and applied within three domains of digitalization (i.e., operational, analytical and collaborative).

The

engines of digitalization refer to four fundamental mechanisms through which 15

digital

technologies

effect

social/economic contexts.

changes

within

organizations

and

their

broader

The domains of digitalization refer to three

fundamental spheres of organizational activity within which digitalization occurs. The four engines of digitalization (automation, control, empowerment, and interaction) operate individually or in combination in fabricating new forms of digitalization.

Definitions of and examples of the benefits to be obtained from

applying these digitalization engines are provided in Table 1-3. Table 1-3 Four Engines of Digitalization

Digitalization Engine

Definition

Examples of Realized Benefits

Simplifying & digitalizing complex tasks & task-sequences, eliminating unneeded tasks, and, as appropriate, performing tasks via digitalization rather than via humans.

•Cost reduction. •Transaction cycle-time improvement. •Responsiveness improvement. •Productivity improvement.

Control

Embedding digitalized rules to identify out-of-control events/situations, such that out-of-control events/situations either do not occur or, if they do occur, are quickly addressed.

•Real-time event/situation monitoring. •Real-time event/situation visibility. •Minimizing the occurrence of inferior decisions & inferior actions.

Empowerment

Providing humans facing decisions with timely, accurate & comprehensive information and with easy-to-use, relevant decision aids & business intelligence tools.

•Broad distribution of and access to data, information & knowledge. •Broad availability of & access to decision aids & business intelligence tools.

Enabling humans, digitalized solutions or both to engage in timely, meaningful dialogues (overcoming barriers of space and time).

•Complex & non-routine business activities handled quicker & better . •Problems & opportunities handled quicker & better. •Innovative activities handled quicker & better.

Automation

Interaction

The

three

digitalization

domains

(operational,

analytical,

and

collaborative) are best seen as being complementary. In other words, a specific digitalization initiative might target, within a specific entity (i.e., one or more of an organization’s subunits, the entire organization, subunits of a set of cooperating organizations, etc.): a single domain, two of the three domains or all three of the 16

domains. Definitions of and examples of the benefits to be obtained within each domain from digitalization are provided in Table 1-4. Table 1-4 Three Domains of Digitalization Digitalization Domains

Operational

Analytical

Collaborative

Definition

Examples of Realized Benefits

Organizational activities involved in getting tasks done. The entities engaged in task-related activities could include digitalized solutions, humans, teams, organizational subunits, organizations and/or sets of collaborating organizations.

•Enhanced task effectiveness (accuracy, comprehensiveness, timeliness, convenience, etc.) •Enhanced task efficiency (productivity, cost, error, rework, etc.)

Organizational activities involved in improving understandings of what things should be done, what things need to be done, what things can be done, how things are done, and how what has been done is assessed.

•Enhanced decision effectiveness (accuracy, comprehensiveness, timeliness, convenience, etc.) •Enhanced decision efficiency (productivity, cost, error, rework, etc.)

Organizational activities involved in enabling digitalized solutions, humans and/or organizational entities to share data, information & knowledge and to cooperate in making decisions and in getting things done.

•Enhanced task effectiveness •Enhanced task efficiency •Enhanced decision effectiveness •Enhanced decision efficiency

Table 1-5 presents an overview of the key features of each of the three eras of digital disruption. A few aspects of this table would benefit from a brief introduction before each of the eras is described. First, an architecture refers to an overarching design framework specified to (1) maintain established policies, e.g., all digitalized transaction-handling should make use of a common database, and (2) enable component interoperability, e.g., all business applications should operate through the use of an agreed-on set of communications devices.

When two or more digital

solutions are interoperable, these solutions are able to seamlessly exchange data and able to apply these exchanged data.

Second, digital technologies can be

proprietary or open. Stated simply, a proprietary technology is tightly controlled by its developer, while an open technology is available for use (and for modification) 17

by anyone (though some form of payment may be required to gain access to the technology). Third, the lower part of the table illustrates the relative extent to which each era exploited the four engines of digitalization. As can be seen below, while digitalization in Era 1 focused on automation and control, Era 3 digitalization is characterized by high levels of each of the digitalization engines. Table 1-5 An Overview of the Three Eras of Digital Disruption Era 1

Era 2

• Data Processing • Proprietary Connectivity

Key Digital Computer systems, remote Technologies terminals, networks, database management, packaged software

Era 3

• Coordination • Open Connectivity

• Mobility • Ubiquitous Connectivity

Personal computers, servers, ERP systems, analytics software, World Wide Web

Smart personal devices, social technologies, Internet of Things, Big Data

Digitization Architecture

Centralized

Connectivity Architecture

One-to-Many Proprietary

Digitalization Architecture

Transaction Handling

Decision/Action Coordination

Value-Unit Enhancement

Digitalization Purpose

Efficiency

Optimization

Community-Building

Distributed One-to-Many Open

Many-to-Many Proprietary

Ubiquitous Many-to-Many Open

Digitalization Engines Automation Control Empowerment Interaction

Organizations recognized as digitalization leaders during Era 1 emphasized automation and control, driving growth and profitability through heightened efficiency. During this era, most typically, digitization was centralized, connectivity accentuated establishing proprietary links with preferred suppliers/customers, and digitalization focused on the handling of transactional data and the use of these data in supporting operational decisions and actions. Table 1-6 provides a brief glimpse

18

of innovative initiatives introduced by two Era 1 disruptors: American Airlines and Merrill Lynch. Table 1-6 Era 1: Innovative Digitalization Initiatives American Airlines Sabre Reservation System Digitalization Realized Benefits Common database of current flights, routes & pricing offered by multiple airlines. Desktop-based software allowing travel agents to dial-in to the Sabre System to search for flights & prices and to make direct bookings.

Enabled travel agents to book passenger flights with greater efficiency, speed & flexibility. In this booking process, American used the system to display its own flights before other airlines’ flights, increasing American’s bookings.

Merrill Lynch Cash Management Account Digitalization Realized Benefits Integrated database of all of a business customer’s accounts (e.g., savings, checking, brokerage). Digitalized decisionmaking system enabling a business customer to log onto their Cash

Other airlines paid a fee to American for the ability to list their flights and an even Management Account higher fee for a priority listing. to track investment opportunities and to American gained valuable execute accountintelligence about related actions. competitors’ prices & routes.

Offered business customers a financial management service for maintaining a desired level of liquidity while sweeping daily excess cash into higher-yield brokerage accounts. The digitalized decisionmaking system monitored market conditions and executed customer-initiated actions across a customer’s accounts.

Organizations recognized as digitalization leaders during Era 2 continued emphasizing automation and control, but also made significant headway with empowerment (via Enterprise Resource Planning systems and business analytics) and interaction (via the open connectivity offered by the technologies that underlay the World Wide Web), further boosting growth and profitability by tightly coordinating decisions and actions. Typically, digitalization was distributed across centralized and localized sites, connectivity proliferated across value-stream participants via open one-to-many connections (B2C e-commerce) and proprietary many-to-many connections (B2B), and digitalization focused on coordinating operational and tactical decisions and actions both within and across organizations’ boundaries. Table 1-7

19

provides a brief glimpse of innovative initiatives introduced by two Era 2 disruptors: United Parcel Service (UPS) and Boeing. Table 1-7 Era 2: Innovative Digitalization Initiatives United Parcel Service (UPS) Package Flow System Digitalization Realized Benefits Smart (bar-coded) labels are placed on packages, providing detailed Loads are balanced across delivery trucks, drivers & routes. information. Routes are optimized to Once a package increase efficiency & arrives at a effectiveness. Delivery Center, truck loading Drivers are able to speed up plans and delivery deliveries and to make more routes are deliveries on a route. optimized. Route details are sent to drivers’ hand-held devices.

Boeing 777 Parts Tracking System Digitalization Realized Benefits Parts delivery processes from suppliers to Boeing capture real-time data (across the globe) on movement, route location, weather conditions and road conditions. Parts delivery processes are coordinated & optimized (part manufacturing lead times, modes of transport, delivery routes).

Costs are better contained (delivery, inventory, assembly) while handling over 3 million parts from over 500 (domestic & international) suppliers. Parts arrive as they are needed in the assembly process.

Organizations recognized as digitalization leaders during Era 3 emphasize all four engines of digitalization: automation, control, empowerment and interaction. Especially important for heightened empowerment and heightened interaction is the mobility and ubiquitous connectivity offered through the convergence of smart personal devices

(e.g.,

smartphones

and

tablets),

the

Internet

of

Things

(miniaturized microcircuitry embedded within all types of products), and the advanced analytics made possible through Big Data (streams of digital data created via the real-time capture of messages and events). Along with new efficiency and optimization opportunities, growth and profitability are being spurred through the active formation and mobilization of the stakeholder-communities (e.g., material and component suppliers, services providers, producers, retailers, and/or consumers) 20

that comprise market-focused ecosystems. Today, digitization and digitalization are both on the verge of being ubiquitous, connectivity is increasingly many-to-many and open, and digitalization focuses on value-unit (e.g., products, services, and/or information) enhancement.

Table 1-8 provides a brief glimpse of innovative

initiatives introduced by two Era 3 disruptors: LEGO6 and Airbnb. Table 1-8 Era 3: Innovative Digitalization Initiatives LEGO LEGO Ideas Digitalization Realized Benefits A digitally-enabled open community where LEGO fans: propose ideas for new LEGO sets (using existing LEGO bricks), review proposed ideas, and vote on proposed ideas. Ideas receiving 10,000 votes within a year are moved into LEGO’s product development process.

Thousands of fresh and innovative ideas are proposed for new LEGO sets.

LEGO sets obtaining 10,000 or more votes are likely to be market successes.

Since 2014, nine new LEGO sets have evolved from the LEGO Ideas program.

The interactions occurring across the fan community (as ideas are reviewed & actively supported) provides essentially free promotion for LEGO.

Airbnb Community Center Digitalization Realized Benefits A digitally-enabled community of Airbnb hosts where ideas & advice are exchanged, thus easing the effort taken by participants in learning how to succeed as a host.

A relatively low cost mechanism for: • Educating & supporting new hosts. • Establishing & evolving a desired culture across the host community. Topics are • Building enthusiasm & personalized to a comradery across the host’s language and host community. country, hot topics • Mobilizing local hostare promoted, and top communities’ face-tocontributors are face sharing and listed. political action.

Revisiting Fortune’s Most Admired Companies Table 1-9 revisits our synthesis of Fortune’s annual listing of the most admired companies. Now, however, many of the table cells are color-coded: 

Red – digital technology product/service providers



Blue – Era 1 organizations listed multiple times

O. El Sawy, H. Amsinck, P. Kraemmergaard and A.L. Vinther, “How LEGO Built the Foundations and Enterprise Capabilities for Digital Leadership,” MIS Quarterly Executive, June 2016, pp. 141-166. 6

21



Orange – Era 2 organizations listed multiple times



Green – Era 3 organizations listed multiple times

Two key insights about successful digital strategizing can be gleaned from this table. Table 1-9 Revisiting Fortune’s Most Admired Companies Rank

Years

1

2

3

4

5

2014-2016

Apple

Google

Amazon

Berkshire Hathaway

Walt Disney

2011-2013

Apple

Google

Amazon

Coca Cola

Berkshire Hathaway

Toyota Motors

Johnson & Johnson

2008-2010

Apple

Google

Berkshire Hathaway

2005-2007

General Electric

Starbucks

Southwest Airlines

FedEx

Berkshire Hathaway

2002-2004

Walmart

Southwest Airlines

General Electric

Berkshire Hathaway

Microsoft

1999-2001

General Electric

Microsoft

Walmart

1996-1998

Coca Cola

Microsoft

Intel

1993-1995

Rubbermaid

Coca Cola

1990-1992

Merck

Rubbermaid

Walmart

Proctor & Gamble

PepsiCo

1987-1989

Merck

Rubbermaid

Liz Claiborne

3M

Boeing Phillip Morris

1983-1986

IBM

Dow Jones

HP

Merck

Coca Cola

Cisco Systems Dell Southwest Airlines Merck

Johnson & Johnson

3M

Home Depot

Microsoft

First, the highlighted companies in Eras 1 and 2 all represent pipeline organizations, aside from Berkshire Hathaway.7 In Era 3, however, the highlighted firms

(again,

aside

from

Berkshire

Hathaway),

represent

a

pure

network

organization, i.e., Google, and two blended organizations, i.e., Apple and Amazon.

General consensus suggests that Berkshire Hathaway’s success as a holding company rests on three factors: acquiring exceptionally well-run businesses, retaining these businesses’ existing leadership teams and allowing these leaders considerable autonomy to run their business, and moving slack financial resources across these businesses to take advantage of temporal and sectoral opportunities. 7

22

Blended organizations operate both as pipeline organizations and as network organizations: 

Apple produces consumer-oriented technology products via tightly-managed value streams and orchestrates iTunes and Apple Music, markets that bring together communities of music producers and music consumers.



Amazon manages a pipeline-like B2C e-commerce business and orchestrates consumer and business marketplaces, bringing together communities of sellers and consumers.

We anticipate that organizations’ digital strategies will increasingly incorporate elements of both pipeline organizations and network organizations. Second, highlighted organizations in Eras 1 and 2 include technologyproducing firms and technology-using firms. Era 3, however, lacks pure technologyproducing firms. Instead, Apple, Google and Amazon are both producing (alone and with strategic partners) advanced digital technologies and introducing streams of digitalization innovations. Additionally, Google and Amazon are technology services providers. Interestingly, the highlighted Era 2 organizations, i.e., General Electric, Southwest Airlines and Walmart, were noted for their large and superb technology groups that, alone and with strategic partners, introduced streams of digitalization innovations.

We anticipate that organizations’ digital strategies will increasingly

incorporate homegrown digitalization innovations. The Evolving Landscapes of Industries The constant threat of digital disruption places organizations’ leadership teams in increasingly hostile and competitive environments. A variety of competitors exist (nimble digital startups, established companies with strong market positions and well-honed operational processes, and everything in-between) across all industry

23

sectors.

N. Venkatraman8 provides a framework for understanding the industry

forces now at play by identifying the three sets of influential competitors that are active in most industries today: 

Incumbents: These are firms who have been traditionally operating in an industry for a long time with well-established business models, organization structures, and resource control structures. Many of these incumbents have attained industry leadership positions by virtue of their mastery over business models. For example, CBS, Disney, ABC, Comcast, Verizon, and AT&T would be considered to be examples of incumbents in the entertainment and media industry.



Digital Giants: These firms have mastered digitalization and are able to harness their business models and digitalization expertise to disrupt a wide range of industries. Well-known digital giants include Google (Alphabet), Facebook, Amazon, Apple, and Microsoft, each of whom has demonstrated a sustained prowess in digital disruption across multiple industries.



Technology Entrepreneurs: These firms are younger or smaller firms that bring specialized digitalization expertise to innovate, transform or disrupt certain aspects of an industry’s value stream or value-units (i.e., product or services offerings). Examples of such firms for the entertainment industry would be Sling and Hulu.

Industry strategic landscapes today must be seen as being populated by not only incumbents, but also by digital giants and technology entrepreneurs.

As a

consequence, digital strategists within today’s emerging market-focused ecosystems must weave together the interests and capabilities held by incumbents, digital giants and technology entrepreneurs in fashioning the business models most likely to produce competitive success. A Recap and Look Ahead Conventional notions about competitive strategy are being challenged with the power of digital technologies to provide the means for innovation, organization

N. Venkatraman, The Digital Matrix: New Rules for Business Transformation through Technology, Life Tree Media, 2017. 8

24

transformation, and market disruption. As firms across all industries are feeling the heat, it is imperative that fresh ways of thinking are surfaced about the nature of competition and about what is needed to achieve competitive success. The next chapter provides insights regarding these fundamental ideas that underlay effective digital strategies.

25

Chapter 2. Digital Strategy Fundamentals

How should firms master the challenges and opportunities of digital innovation and disruption? What types of models and mindsets will help managers effectively lead their organizations in today’s digital economy?

The following three sets of

fundamental ideas regarding digital strategy are described in this chapter: 

The Goal of Digital Strategy: Agility



The Grammar of Digital Strategy: Business Models



The Logic of Digital Strategy: Competitive Moves

The Goal of Digital Strategy: Agility In modern competitive arenas, the pursuit of sustained competitive advantage is an illusion because of the tremendous disruptive pressures facing firms and industries.

Therefore, the hallmark of a successful digital strategy is succinctly

described via the concept of agility. Agility is a firm’s ability to detect potentially disruptive threats and opportunities and, then, to marshal the resources and managerial insights required to subdue threats and/or exploit opportunities. Agility addresses two seemingly contradictory objectives: achieving stability, i.e., the ability to withstand disruptions by maintaining operational reliability and efficiency; and, achieving dynamism, i.e., the ability to innovate, transform and disrupt by demonstrating strategic adaptability, speed and entrepreneurism. In essence, agility requires organizations to execute a portfolio of business models that simultaneously account for two aims – ensuring stability in currently-executing operational processes (so as to meet stakeholders’ expectations and competitors’ performance levels), and ensuring an ongoing stream of well-founded, future-oriented competitive actions. 26

This duality is reflected in the need for competitively-successful organizations to exhibit two forms of agility. Adaptive agility refers to the ability to aggressively introduce incremental enhancements into currently-executing business models, whereas entrepreneurial agility refers to the ability to aggressively introduce radical enhancements into currently-executing business models or to introduce new business models. Adaptive and entrepreneurial agilities are important because the only sure thing that can be said about today’s market ecosystems is that they are highly uncertain as a consequence of: 

Finely-tuned and highly-differentiated consumers.



Near-constant value-unit innovation and operational process innovation.



The regular appearance of new entrants (startups, established players from adjacent markets, digital giants, technology entrepreneurs).



The periodic restructuring of value-streams and participants’ relative influence within market-focused ecosystems.

To paraphrase Project Runway’s Heidi Klum: one day you’re in and the next day you’re out. Extending, or even maintaining, a strong competitive position demands a continual stream of well-targeted competitive actions. Therefore, organizations’ digital strategies are unlikely to take the form of methodically-stipulated, lengthy (over a two- or three-year planning horizon) and tightly-coordinated series of competitive actions. Instead, organizations’ competitive actions are most likely to occur opportunistically or reactively, but in accordance with a strategic intent that establishes strategic direction and strategic purpose.

A

strategic intent directs digital strategists’ thought processes as competitive moves are formulated and implemented – without dampening the flexibility and autonomy 27

necessary and adaptive/entrepreneurial agilities. A broadly-communicated strategic intent focuses strategists’ opportunity-seeking, thereby exerting a dominant influence on the formulation of competitive moves (see Figure 2-1). Even though organizations’ strategic intents do evolve, they serve the critically important role of ensuring that organizations’ investments in digital resources are guided in a consistent fashion across time – increasing the likelihood that new investments leverage and complement in-place resources. Figure 2-1 The Influence of Strategic Intents on Competitive Moves

Competitive Moves

Strategic Intent

Digital Strategists’ Knowledge, Perspectives & Insights

Business Model Enhancement, Replication & Innovation

Competitive Outcomes

A strategic intent is derived from the knowledge, perspectives and insights held by digital strategists.

In envisioning and evolving a strategic intent, an

organization’s digital strategists are especially influenced by their understanding of the core capabilities that underlie the value propositions expected to most appeal to consumers and the extent to which their organization has digitalized these capabilities – key underpinnings of a business model. 28

The Grammar of Digital Strategy: Business Models Business models reflect the choices made by organizations’ leadership teams about how value is created and how profitability is realized. As shown in Figure 2-2, there are four distinct elements of agile business models: 

A value proposition defines how an organization will distinguish itself within the market(s) that it has chosen to participate. Pipeline organizations distinguish themselves by creating value for consumers. Network organizations distinguish themselves by creating value for participating communities.



A profit model consists of revenue and cost models. Revenue models describe where, when, and how sustainable revenue streams materialize. Cost models describe the costs to be borne in producing the revenue streams and how these costs will be controlled to provide requisite levels of profitability.



Core capabilities refer to the tangible resources (e.g., facilities, machinery, digital devices, etc.) and intangible resources (e.g., people, knowledge, operational and managerial processes, patents, architectures, etc.) needed to successfully implement the value proposition and profit model.



Dynamic capabilities refer to the intangible resources (e.g., people, knowledge, relationships, managerial processes, architectures, etc.) needed to (1) sense and assess opportunities for business model enhancement, replication and innovation, and (2) successfully implement these enhancements, replications and innovations.

Figures 2-3 and 2-4, respectively illustrate each of these elements via portraits of agile business models reflective of Apple’s participation in the consumer smart device market and Walmart's participation in the retail market.

29

Figure 2-2 Elements of an Agile Business Model

•What is the value-unit? •Who is the consumer? •What does the consumer desire and expect with regard to this value-unit?

Value Proposition

•How is revenue generated? •What is the cost structure? •How is profit created?

Profit Model

Core Dynamic Capabilities Capabilities What are the resources & activities critical to providing consumers with a value-unit they value and to do so in a profitable manner?

What are the resources & activities critical to ensuring that well-founded business model enhancements, replications & innovations are undertaken to maintain competitive positions within the markets we participate and the new markets we enter?

Figure 2-3 Apple’s Business Model for the Consumer Smart Device Market • Value-unit: Consumer smart digital devices • Consumer: Technically-receptive & technically-savvy segments of the personal smart device market • Innovative & trend-setting products • Seamless access to content across all digital media

Value Proposition

Profit Model

Core Capabilities

Dynamic Capabilities

Brand management Technology patents Product design & product architecture design Tightly-directed sales & marketing Tightly-controlled manufacturing & logistics, performed by third-parties • Relationships with content providers and with manufacturing & logistics partners • • • • •

• High product prices driven by stimulating demand and by limiting supply • Moderate manufacturing & marketing costs • High margins

• Knowledge of new digital technologies • Knowledge of evolving desires of firstadopter consumers • Knowledge of new digital media and of new means for accessing digital media • Knowledge of product designers & architects • Knowledge of content management architects

30

Figure 2-4 Walmart’s Business Model for the Retail Market • Value-unit: Household groceries & products • Consumer: Cost-sensitive segment of the mass market • ‘Everyday Low Prices’ • Retail store availability of a broad range of products, enabling one-stop shopping

Value Proposition

• Low prices, low costs • Moderate margin • High volume, high product turnover

Profit Model

Core Dynamic Capabilities Capabilities • Store site selection & store layout design • Tailor local inventory to local market • Shelf-space optimization (merchandizing & replenishment) • Logistics optimization • Supplier relationships

• Knowledge of new digital technologies • Knowledge of evolving shopping-experience desires of mass-market consumers • Knowledge of digitalization trends & innovations in retail-store operations and in logistics • Logistics designers & technologists • Retail store designers & technologists

Value disciplines are a fundamental element of business models and align the value propositions with the expectations of their consumers.9

Some types of

consumers seek low prices, quality and convenience; organizations pursuing this consumer adopt the operational excellence value discipline. Other consumers are more concerned with having their needs and preferences met fully and are willing to pay a premium for this to occur; organizations pursuing this consumer adopt a customer intimacy value discipline. Finally, some consumers seek the state-ofthe-art, the trendy and/or the stylish and are willing to pay a premium for this to occur; organizations pursuing this customer adopt a product leadership value

M. Treacy and F. Wiersema, “Customer Intimacy and other Value Disciplines,” Harvard Business Review, January-February 1993, pp. 84-93. 9

31

discipline.

Table 2-1 summarizes the value propositions and core capabilities

associated with each of the value disciplines. Table 2-1 The Three Value Disciplines Value Discipline

Operational Excellence

Customer Intimacy

Product Leadership

Value Proposition

Core Capabilities

 Manufacturing, assembly and/or  Quality, low-cost valuemerchandising unit  Order processing & fulfillment  Reliable, convenient  Inventory management delivery process  Upstream/downstream logistics

 Tailored value-unit  Tailored delivery process

• Micro-segmentation • Consumer relationship management • Advertising & marketing • Campaign management

 State-of-the-art, trendy and/or stylish value units    State-of-the-art, trendy  and/or stylish delivery process

Research & development Rapid commercialization Quality assurance After-sales support

Examples Amazon Dell General Electric FedEx Walmart Amazon Google Harrah’s Kraft Foods Ritz Carlton 3M Apple Intel Merck Johnson & Johnson

General Electric (GE): Operational Excellence in Action GE’s consumer appliance business10 adopted the operational excellence value discipline in the 1980s by introducing the Direct Connect initiative to become a lowcost, hassle-free supplier to appliance dealers. Historically, the company fully loaded its dealers – that is, it expected dealers to stock full inventories of appliances by incentivizing them to purchase full truckloads.

This strategy lost favor when the

independent dealers began to face severe competition from lower-priced, multi-brand chains such as Best Buy.

As part of their Industrial Internet business strategy, GE sold their appliance business to Qingdao Haier in 2016. 10

32

With the Direct Connect initiative, dealers were no longer required to maintain their own inventories of major appliances. Instead, they could rely on GE’s virtual inventory – a digitalized merchandizing and inventory system that allowed the dealers to retrieve information about available appliances, sell them to their customers, provide these customers with delivery information, and have the appliances shipped directly to the customers from GE distribution centers. The Direct Connect initiative not only reduced the inventory carried by dealers, but provided the dealers’ customers with access to the full breadth of GE’s appliance product lines. GE now links this dealer-order processing system to its forecasting and demand planning processes, enabling GE to manufacture to the product sales rather than to dealers’ inventories. Since 2011, GE has been transforming itself through a multibillion-dollar initiative called the Industrial Internet. Essentially, GE has embraced the Internet of Things and the world of Big Data by embedding sophisticated digitized sensors to its machines and connecting the ensuing data streams to operational and analytical platforms. While GE has long embedded sensors in its machines, the data from these sensors was primarily accessed and used on-site by repair and maintenance technicians.

Today, the huge volumes of data being captured are transmitted to

digitalized platforms enabling a broad spectrum of operational and managerial processes. As an example, consider GE’s jet engine business, whose business model is built around the product leadership value discipline. Noticing that some of its engines were beginning to require more frequent unscheduled maintenance, GE engineers aggregated and analyzed real-time functioning, maintenance and performance data 33

for every jet engine in use across the globe. Through this analysis, the GE engineers were able to identify the problem: engines operated in harsh conditions (e.g., heat, humidity, dust, smog, etc.) tended to clog, heat up and function inefficiently. By thoroughly cleaning the engines used on such routes more frequently, engines operated more efficiently, required less maintenance and exhibited longer peak lifetimes – saving airlines millions of dollars annually in fuel costs. But, designing, building, installing, operating and maintaining state-of-the-art, interconnected machines demands operational excellence. All of this has dramatically transformed the business model of GE’s jet engine business.

The value proposition involves two value disciplines requiring a broad

range of core and dynamic capabilities; and, the profit model has shifted from being based solely on revenues from sales transactions to one based on revenues from sales transactions and from a contracted portion of airlines’ savings from better performing engines (engine operating and maintenance costs, aircraft miles flown per year, etc.). Kraft Foods: Customer Intimacy in Action In packaged food pipeline ecosystems, the focal market exchange is that between a shopper and a retailer. For producers like Kraft Foods, the immediate consumers, or customers, are grocery retailers.

By tailoring promotions,

merchandizing and logistics relationships with retail stores (or clusters of stores associated with the same retail chain), Kraft was among the first firms to apply analytics in reaching out through retail stores to the stores’ consumers to benefit both the stores and Kraft.

34

Kraft decentralized much of its marketing to sales teams holding relationships with retail stores (or store clusters) and built a marketing analytic capability that combined data from three sources: digitized sales transactions from the retail stores, demographic and buying-habit data on the customers of 30,000 food stores nationwide, and an external geo-demographic database organized by nine-digit zip code.

A centralized group of marketing specialists and brand specialists applies

analytics to develop deep understandings of how sales of products, product categories and brands vary by store, retailer, geographic area, customer segment, time-of-the-year, etc., and how these sales are influenced by taken-actions, e.g., campaigns, coupons, sales, displays, product-shelfing, etc. This centralized group then consults with the decentralized sales teams as the teams plan for subsequent retail account interactions, i.e., creating customized, store-level promotional programs. More recently, Kraft has broadened their consumer-outreach in three major ways. First, as Kraft now reaches shoppers through B2C sales channels (pure-play online retailers such as Amazon and mixed-play retailers such as Target and Walmart), Kraft’s retail analytics and retailer relationship programs have had to account for the nuances of e-commerce.

Second, while not selling directly to

shoppers, Kraft is building online shopper communities, e.g., social media channels, www.kraftrecipes.com and the iFood Assistant app, that are used to build awareness about and promote Kraft products and brands and to interact with shoppers. Third, the streams of data gathered from these online communities have been incorporated within Kraft’s analytics platforms – enabling marketing and brand specialists to tap into the fuzzy front-ends of shopper wants and needs (e.g., flavor trends, absent35

but-desired

products,

in-store

or

online

shopping

likes/dislikes,

promotions

likes/dislikes, brand perceptions, etc.). Insights such as these, when combined with the results of more-traditional marketing analytics, can be invaluable for a broad array of marketing decisions, including: establishing brand pricing strategies, filling out

product

lines,

planning

joint-brand/product

promotions

(single

product

promotions can cannibalize overall sales), and optimizing promotional spending across media. Apple: Product Leadership in Action Following Steve Jobs’ leadership, Apple has very successfully pursued the product leadership value discipline. Because Apple’s products are perceived by its customers as innovative, trendy, reliable and easy-to-use - and as providing the purchaser with peer-group panache - Apple is able to command premium prices for their products. The firm has accomplished this by maintaining tight control of product design and development and by reinforcing the Apple brand through stylistic promotional programs and uniquely designed retail stores. Apple’s approach to product leadership is not to tap into the leading edge of consumer trends, but rather to inspire these trends. It is not enough to understand your customer’s desires - Apple’s objective is to create these desires. Clear examples of this are the iPod, the iPhone, the iPad and, most recently, the Apple Watch. The Apple Watch, for example, is not intended to be a smaller, wearable version of the iPhone. Instead, the Apple Watch is envisioned as a lifestyle accessory that brings the digital content most meaningful to a person in real-time at the turn of the wrist. Was this something that the consumer needed before it was released? Not likely. But, it is Apple’s expectation that, after becoming aware of the usefulness of the 36

Apple Watch, its targeted consumer segments will perceive not only that this need is real, but that it has always existed. In order for Apple’s market success to continue into the future, two factors are crucial: releasing a steady stream of exciting products, and growing its extremely loyal (some might say insanely loyal) customer base. The first of these factors is captured with the product leadership value discipline, and the second with the customer intimacy value discipline. Apple’s more recent focus on customer intimacy is perhaps best represented by the opening, growth and market success of the Apple Store. As conceived by Apple, its retail stores are more than just stores. Instead, the Apple Store is intended to be an inviting and creativity-releasing space where people are exposed to a variety of enriching experiences: trying out new products, learning how to do neat things with a product, overcoming product usage problems, being exposed to new ideas (about technology, art, music, culture, entrepreneurial startups, etc.), interacting with others on topics of mutual interest, and, most simply, being entertained. The objective, thus, is to fashion and reinforce stronger consumer relationships, one at a time. Final Thoughts about Business Models As a final point, the digital strategy for a given organization often involves multiple business models. Multiple business models arise because most organizations participate in multiple, differing markets. While Walmart’s digital strategy is directed toward a single, overarching business model, Apple‘s digital strategy incorporates two overarching business models: one associated with the consumer smart device pipeline ecosystem, and the other with the iTunes business model that operates as a network ecosystem. Further, while the digital strategy for a holding company such 37

as Berkshire Hathaway is framed around a single dominant business model, each subsidiary’s digital strategy is framed around one or more self-contained business model(s). The Logic of Digital Strategy: Competitive Moves The third element of the modern approach to digital strategy recognizes a dynamic perspective realized through competitive moves and countermoves. Unlike the traditional perspective on strategy that is based on competing around static positions, the dynamic perspective emphasizes the continual pursuit of competitive advantage through innovations in business models, products and services.

Agile

firms regularly conduct small-scale, tightly-contained strategic experiments to learn about potential innovations and disruptions and then adapt their business models for strategic success.

In his recent book, Venkatraman11 describes three

types of competitive moves that collectively represent the logic of digital strategy: 

Experimentation at the Edge



Collision at the Core



Reinvention at the Root

Each of these are now briefly described. Experimentation at the Edge Today, in virtually every industry, technology entrepreneurs are developing new digital business models that have the potential to cause dramatic disruptions and transformations. History is replete with examples of such disruptors: Amazon

N. Venkatraman, The Digital Matrix: New Rules for Business Transformation through Technology, Life Tree Media, 2017. 11

38

and the retailing industry (1995), Netflix and the movie rental business (1998), Uber and the people transportation industry (2011), Tesla and the automobile industry (2014), etc.

All firms must direct their managers’ attentions and their resources

toward understanding and recognizing the plethora of business model experiments that might possibly affect their industry. Consider the many ongoing experiments occurring today with Bitcoin. Though its implications and business trajectory are not clear today, no financial services firms can afford to ignore experiments around this fintech-created opportunity. incumbents

and

new

The leadership teams of industry participants (both

entrants)

must

manage

their

attention

toward

experimentation at the edge of their industries or ignore them at their own peril. Collision at the Core Consider

the

automobile

industry

today.

Should

the

automotive

manufacturers still be making cars or are they in the business of mobility solutions? The smart money would be on the latter and this would have significant implications for the business models and ecosystems of today’s automobile industry. Apple’s Car Play entertainment, Google’s Waymo self-driving car technologies, Peloton’s automated transportation solutions, and Mobileye’s advanced driver assistance systems are all examples of novel solutions that are likely to affect, in yet undetermined ways, the core of today’s automotive industry. Every car manufacturer is reexamining its business models, ecosystems, and offerings to develop the needed adaptive and entrepreneurial agilities. The jury is out on how we will view cars and mobility solutions ten years from now and what will be the ownership and consumption models affecting the fortunes of car manufacturers. However, it is quite clear that during the past three years, the industry’s business models are undergoing 39

significant transformations.

Savvy firms participating in automobile-related

ecosystems are examining a breadth of collision at the core competitive moves aimed at renovating industry ecosystems and business models by establishing relationships with digital giants and technology entrepreneurs, committing to investments in new digital capabilities, and reinventing organization structures and incentive systems to attract the needed in-house talent. Reinvention at the Root It seems we continue to hear, almost daily, about the demise of the traditional retail industry and the emergence and dramatic growth not just of Amazon, but of other digital retail firms. The fundamental business models of retailing have been reinvented and the industry is witnessing a shakeout, with many of the traditional incumbents on the verge of disappearing. But, some incumbents are doing fine with their digital transformations (e.g., Walmart, Target, Walgreens, Starbucks, Sephora, Macy’s, Marks & Spenser, IKEA, Nordstrom, among others). Invariably, these successful retailers: actively engage in experimentation at the edge and collision at the core competitive moves, and introduce radical changes to their business models as they move toward becoming, to varying extents, blended organizations. Reinvention at the root refers to competitive moves aimed at cannibalizing traditional capabilities and scaling up significant investments in new digitization and digitalization capabilities. The Logic of Digital Strategy Formulation and Evolution Figure 2-5 depicts the central role served by competitive moves in the process of digital strategy formulation and evolution – a process that begins and evolves

40

through the knowledge, perspectives and insights held by digital strategists. Four domains of knowledge, perspectives and insights are especially critical: 

Currently-executing business models.



The markets within which these business models are executing.



Markets adjacent to those within which the current business models are executing. Increasingly, the genesis of radical business model enhancement and business model innovation is derived not only from analyzing the outcomes of competitive moves within a targeted market, but also from observing the outcomes of other organizations’ competitive moves in adjacent markets – especially when an adjacent market involves complementary or substitute value-units, similar customer segments, similar value-stream activities, similar strategic partners, etc.



The digitization and digitalization landscapes relevant to the currentlyexecuting business models and to any new business models being formulated, especially as these landscapes affect experimentation at the edge, collision at the core, and reinvention at the root.

Table 2-2 provides overviews of these four domains.

Importantly, the key to

fabricating and evolving effective competitive moves is not necessarily the nature of the specific planning processes applied (many differing planning processes can lead to successful outcomes), but rather to ensure that these planning processes actively involve participants (e.g., digital strategists, leadership team members, functional specialists, etc.) whom collectively hold and/or have ready access to these four domains of knowledge, perspectives and insights.

41

Figure 2-5 The Digital Strategy Formulation and Evolution Process Competitive Moves

Experimentation at the Edge Collision at the Core Reinvention at the Root

Digital Strategists’ Knowledge, Perspectives & Insights

Business Model Enhancement, Replication & Innovation Competitive Outcomes Targeted Market Adjacent Markets

Table 2-2 Key Knowledge-Perspectives-Insights Domains Target Market • Value-units, complements, substitutes • Consumer expectations • Revenue-generating tactics • Value stream participants & activities

Executing Business Models • Value proposition • Profit model • Core capabilities • Dynamic capabilities

Adjacent Markets • Value-units, complements, substitutes • Consumer expectations • Revenue-generating tactics • Value stream participants & activities

Digitization & Digitalization Landscapes • Current digitization & digitalization capabilities • Digital technology advances & innovations • Digitization best-practices, trends & innovations • Digitalization best-practices, trends & innovations

42

A Recap and Look Ahead This chapter has introduced fresh ideas regarding three key elements associated with the formulation of successful digital strategies. First, digital strategists must focus on agility as the predominant goal in formulating their organization’s digital strategy. Successful digital-age firms excel with both adaptive and entrepreneurial agilities. Second, business model design represents the new grammar through which an organization’s digital strategy is formulated and evolved. Digital strategists’ creativity and attention must be focused on business model design, adaptation, and reinvention in response to a plethora of digitalization threats and opportunities. Third, the logic of digital strategy formulation and evolution is based on taking and learning from three types of competitive moves: experimentation at the edge, collision at the core, and reinvention at the root. Bolstered by these ideas, we are now ready to examine how digitalization can be applied to confront digital disruption in, first, pipeline ecosystems and, then, network ecosystems.

43

Chapter 3. Digitalized Business Models for Pipeline Ecosystems

Over the last century, pipeline ecosystems have been the dominant organizing paradigm. In just about all established economic arenas, e.g., automotive, packaged foods, personal care goods, pharmaceuticals, smartphones, mobile communication services, healthcare services, big box retailers, etc., value-units are delivered to consumers through tightly-coordinated value streams. This chapter examines the nature of pipeline ecosystems by describing: 

Why Pipeline Ecosystems Exist



Digitalizing Pipeline Ecosystems



Disintermediation, Reintermediation and Intermediary Transformation

Why Pipeline Ecosystems Exist Figure 3-1 depicts a simplified industry value stream for companies - like Ben and Jerry’s, Häagen-Dazs, and Baskin Robbins - that produce ice cream (through a mix of upstream channels) and then market finished products to consumers (through a mix of downstream channels).

In such a pipeline ecosystem, the ice cream

producer determines which ice cream raw materials, flavors and delivery channels are likely to be most favored by consumers and fashions a value stream to produce and deliver ice cream products to these consumers. However, if one or more of the upstream/downstream participants does a poor job carrying out its responsibilities, or if the ice cream producer does a poor job anticipating the consumers’ expectations or coordinating value stream work flows, then the consumers’ expectations will not be met. Further, because of the complexities involved in coordinating value stream work flows, the producer could choose to perform all of the activities involved with 44

the value stream, i.e., be fully vertically integrated. However, as explained below, it usually is neither economically nor operationally desirable for the producer to do so. Three concepts explain why this is the case: economies of scale and scope, transaction costs, and intermediation. Figure 3-1 Ice Cream Industry Value Stream Upstream Activities

Midstream Activities

Ice Cream Production

Consumers

Distributors

Ice Cream Production

Ice Cream Ingredient Suppliers

Downstream Activities

Ice Cream Storage & Shipping Retailers

Retail Store

Packaging Suppliers

eCommerce Paper Suppliers

Economies of Scale and Scope Economies of scale refers to the advantages that arise with increased volume of output, and economies of scope refers to the advantages that arise when a family of related goods are produced rather than a single good.

Viewed most

simplistically: by covering fixed costs with larger activity volume, the cost to execute the activity drops; by specializing in an activity, the activity’s variable costs can be reduced through experience, analysis and training; by performing a set of similar activities, the fixed and variable costs of each activity can be reduced.

It is the 45

existence of economies of scale and scope that are at the basis of the consideration given by most producers to using the services of other organizations to carry out many, if not most, value stream work activities. Transaction Costs Transaction costs are involved with a fundamental market-related decision, generally referred to as the make-versus-buy decision: when does a company (individual) decide to make an item or perform an activity itself (herself) rather than another company (person) make the item or perform the activity? Answering this question is intuitively simple: compare the total cost of doing it yourself against the total cost of having someone else doing it for you. The total cost to produce an item or perform an activity can be represented as sum of associated production and transaction costs. Production costs are the direct costs to produce an item or perform an activity; transaction costs are the additional costs involved when an item or activity is acquired from someone else. Table 3-1 defines common transaction costs.

46

Table 3-1 Common Transaction Costs

Types of Transaction Costs Search

Description Locating suppliers willing & able to provide goods & services. Locating buyers willing & able to purchase good & services. Assessing bids.

Bid Selection

Assessing suppliers/buyers. Selecting a supplier/buyer.

Contract Negotiation Bonding Legal

Monitoring

Determining mutually agreeable contract provisions. Renegotiating contract provisions.

Insuring against failure to deliver/purchase. Insuring against substandard performance. Insuring against inadequate contract provisions. Monitoring ongoing supplier/customer performance. Deciding to terminate or renegotiate contract.

Because of economies of scale and scope, organizations specializing in producing a family of items or performing a family of activities have the potential to provide higher-quality, lower-cost goods and services than does a non-specialist. However, acquiring an item or a service from a specialist always involves transaction costs (refer back to Table 3-1). The key question, thus, becomes: “Overall, is it less expensive to do it myself or to have the specialist do it for me?” Often, the answer is to have the specialist do it for you. Intermediation Intermediation refers to an organization’s choosing to reach suppliers or end consumers through another organization, an intermediary, rather than directly. Say, for example, that you would like a dish of ice cream made by a specific ice cream producer. You could buy a pint directly from a retail store operated by the producer or from a nearby grocery store (who buys the ice cream directly from the producer or, more likely, from a distributor or wholesaler). Unless you live close to a producer 47

retail outlet, the transaction costs (e.g., search, travel, etc.) you would experience are likely to be quite high. As a result, you would not buy a pint of ice cream directly from the ice cream producer; instead, you would buy a pint from a nearby grocery store. Because of such difficulties faced by producers in reaching consumers, most producers use downstream intermediaries in order to reach a large number of consumers.

A similar logic can be applied in explaining the use of upstream

intermediaries. Table 3-2 describes common activities undertaken by intermediaries. Table 3-2 Common Intermediary Activities Types of Activities Performed by Intermediaries Search Efficiency

Demand Aggregation

Create Packages Guarantee Transactions Manage Logistics

Description Locate & procure products/services/information. Locate suppliers. Gather orders from multiple consumers and negotiate prices & contracts with producers. Gather products/services/information from multiple suppliers and negotiate prices & contracts with producers. Buy in bulk and reassemble into packages that meet the needs of specific consumers or producers. Handle complex transactions.

Insure payments & shipments. Delivery of goods: upstream & downstream.

Adding a new intermediary to an existing value stream always introduces additional costs, as each intermediary naturally wishes to make a profit from their involvement in the value stream. However, as these additional profits are spread across the large number of value-units moving through the value stream, it often proves to be the case that both producers and consumers ultimately benefit from the presence of the new intermediary.

48

Digitalizing Pipeline Ecosystems The nature of market-focused ecosystems has evolved dramatically over the three eras of digital disruption, particularly with regard to the value-units delivered to consumers, the enabling digitization and digitalization, and the payment and trust systems employed. Table 3-3 provides an overview of the major changes that have occurred.

The most significant of these changes for pipeline ecosystems are

described below.

Each one of the three eras of digital disruption within pipeline

ecosystems is now described, with this section ending with a discussion of how these changes have resulted in the value streams associated with pipeline ecosystems being

disintermediated,

reintermediated

and

characterized

by

intermediary

transformation. Table 3-3 Evolution of Pipeline Ecosystems

Era

1

2

3

Value-Units

Digitization & Digitalization

Exchange Currency

Trust Systems

Digital complements

 Data/document standards  Point-to-point connectivity  Intra- and inter-organizational (managerial & operational) business process efficiencies

 Banking system  Credit/debit card systems

 Government & thirdparty institutions  Contracts  Brand  Social capital

 Internet  One-to-many connectivity  Data, process, analytic & collaboration platforms  Social media  Omni-channel producerconsumer interaction

 Digitalized payment systems

 Third-party digital trust seals  Consumer monitoring (product & producer reviews)

 Reputation  Social capital  Bitcoins

 Community monitoring  Peer-regulation  Self-regulation

Digital value-units

Social complements

    

Many-to-many connectivity Smart devices Big data platforms Big data analytic platforms Social messaging platforms

49

Era 1 Leadership teams of organization-participants within pipeline ecosystems expect their operations, staff and managerial employees to be looking for ways to enhance value-units, cut costs, improve market responsiveness, and accelerate the development of new, revenue-generating value-units. These beneficial outcomes all derive from efforts taken to improve organizations’ internal managerial and operational processes. Figure 3-2 provides a way to conceptualize these processes.12 Primary processes refer to work activities directly involved in delivering value-units to customers, and support processes refer to work activities that provide direction, resources and oversight for the primary processes. All too often, however, these work activities are hindered by constraints – both real (e.g., time, space, resource limitations, etc.) and imagined (i.e., ingrained in employees’ thinking as a result of culture, history, inadequate supervisory direction, inadequate training, etc.).

This conceptualization is derived from ideas introduced by: M. E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance, New York: Free Press, 1998. 12

50

Figure 3-2 A Pipeline Organization’s Managerial and Operational Processes Business/Digital Strategizing; Administrative Services

Support Processes

Financial Services; Accounting Services

Digital Technology Services & Management Human Resource Recruitment & Development; Benefits Management R&D; New Product Development; New Product Rollout

Primary Processes

Indirect Materials & Supplies Procurement

Direct Materials and Supplies Procurement Inbound Logistics

Manufacturing Work-inProcess Inventory Quality Control

Order Fulfillment FinishedGoods Inventory Outbound Logistics

Sales Marketing Merchandising

Customer Support Reverse Logistics

The availability of new digital technologies, industry data/document standards and results from analyzing digitized transactional data proved instrumental in enabling value stream participants to overcome many of the constraints that otherwise were inhibiting efforts to improve internal processes and external workflows. Data/document standards allow data and documents to be accessed and used by value stream participants.

For example, many industry groups

developed data and document specifications as a means of facilitating B2B transaction flows. This was referred to as EDI (Electronic Data Interchange). As might be expected, EDI made it possible for value stream participants to interconnect their (increasingly-digitized) workflows. When operational processes improve within and across a value stream’s participants, two things occur. First, the performance of the entire value stream improves – to the benefit of all participants, but especially 51

for consumers. Second, as intermediaries are specialized to a greater extent than are producers, intermediaries are able to more-quickly apply process improvements to enhance their business models.

As a result, intermediaries tended to gain

increased influence in value streams and, correspondingly, to increase their relative shares of the value being created.

However, such gains in the influence of

intermediaries were somewhat attenuated by the abilities of creative producers to lower their cost structures and to attach digital complements (e.g., better and more information, information-based services, product/service migration paths, etc.) to the value-units being delivered to, thereby enhancing the producer’s valueproposition and strengthening both the producer’s market position and relative influence within the value stream. For the most part, Era 1 pipeline ecosystems made use of well-established payment and trust systems.

The only true innovation that occurred was the

emergence of a digitally-enabled payment system: credit and debit card payment systems. Era 2 The digital technology that ushered in Era 2 was the development and widespread adoption of the World Wide Web. At its core, the WWW (World Wide Web) serves as a one-to-many connectivity mechanism enabling organizations (and individuals) to store data and documents in an online space such that these data and documents can easily and inexpensively be accessed and used by other organizations (and individuals).

The WWW (along with its enabling technologies) led to three

digitalization innovations that irreversibly disrupted pipeline ecosystems: purelydigital value-units, platforms, and omni-channel promotion, ordering and delivery. 52

Purely-Digital Value-Units Like their physical counterparts, purely-digital value-units do not exist in a vacuum but require a vast enabling-ecosystem. For example, consider a very familiar physical product – the automobile. In order for you to buy a car directly off of the sales lot and drive it, a huge number and variety of things must exist: automobile retailers, service/repair shops, insurance providers, fuel stations, roadways, traffic lights and signage, traffic laws and regulations, etc.

Most important, a

correspondingly huge number of standards need to have been established and need to be followed in order for the entire automobile ecosystem to operate seamlessly. A similar enabling-ecosystem needs to exist for purely-digital value-units, such as digital books, mp3 audio tracks, navigation maps, and digital coupons. Devices must exist through which a purchased value-unit can be accessed and used, retailers must exist to offer the value-unit to a consumer and then deliver a purchased copy to the consumer’s device, and payment systems must exist so that the exchange can take place between the retailer and the consumer. As with physical goods, many standards must be established and followed for the ecosystem to operate seamlessly. Although physical and digital value-units both require enabling-ecosystems, the markets for physical and digital value-units differ in two major ways. First, the cost-structures of digital value-units tend to be much lower than the cost-structures of physical value-units.

Second, long-tail effects characterize digital value-unit

markets to a much greater extent than physical value-unit markets. Relative to digital value-units, physical value units have moderate-to-high initial costs (e.g., design, testing and marketing) and moderate-to-high variable production costs (e.g., labor and materials).

Let us compare the costs between 53

manufacturing a car and developing a digital book. Car manufacturers incur high fixed costs (e.g., large plants, sophisticated manufacturing and design technologies, etc.) and high variable costs (e.g., parts and assembled components, labor).

In

contrast, while a digital book may have high initial costs (the labor costs involved in authoring, editing and formatting the book), a digital book has very low variable production costs - often approaching zero. This is because the costs of replicating digital goods are minimal, unlike most physical goods. For example, the 100th car coming off of an assembly line will cost essentially the same to produce as the first car off of said assembly line. However, the 100th digital copy of a text book costs only a minute fraction of the expense involved in producing the first digital version. The production costs associated with digital goods are dominated by the cost of producing a first copy, with few constraints limiting growth in demand. Simply put, digital goods have far more opportunities for large-scale growth than do physical goods. The long-tail phenomenon refers to the ability of digital markets to offer a far broader variety of value-units than could be offered in comparable physical markets. Participants in physical markets are constrained in the breadth of valueunits being offered because of the costs of holding inventory. Generally, firms strive to offer the 20% of value-units that generate 80% of sales.

It simply is not

economical to cater to the remaining 80%. Consider a hardcopy book that was a bestseller a year ago, but has since been displaced by more recent bestsellers. Even though a small demand for this hardcopy book is likely to persist over time, most hardcopy retailers will keep few, if any, copies of the book on hand due to acquisition costs and physical storage space constraints. Similarly, consider a book on hiking in 54

the Andes mountain ranges written by an authoritative expert. While there might be a sizeable demand for such a book among hiking enthusiasts (especially those planning a near-term hiking expedition in the Andes), the book is unlikely to have the broad popularity needed to merit space on most hardcopy retailer’s bookshelves (unless, perhaps, you walk into a bookstore in Cuzco, Peru). On the other hand, digital retailers are finding it profitable to service the needs of customers whose tastes represent the more specialized products populating the long-tail of the demand spectrum. For example, an MIT study from the early 2000s found that nearly 30-40% of Amazon’s book sales represent products in this longtail.13

This ability of digital markets to service the long-tail of demand can be

explained by a number of factors: 

Digital retailers experience lower costs of stocking inventory because they do not use physical shelf space to stock and display their products. Instead, they apply digitalized product inventories, often including products held by other ecosystem participants.



Digital retailers experience lower costs of promotion and advertising via a proliferation of Internet and social media sites.



Digital retailers experience lower acquisition costs.



Digital markets are not constrained by geography. They can reach customers locally, regionally, nationally or globally. At that scale, digitized retailers can aggregate the demand for niche products to achieve dramatic scale economies.



Digital consumers can make use of digitalized search mechanisms to locate digital retailers and specific digital value-units.



Digital consumers have access to massive amounts of value-unit-related information (e.g., reviews of specific value-units or of value-unit categories, such as lists of the best point-and-shoot cameras).

E. Brynjolfsson, Y. Hu, and M. D. Smith, "From Niches to Riches: Anatomy of the Long Tail," Sloan Management Review, Summer 2006, pp. 67-71. 13

55

Platforms Value streams in pipeline ecosystems become longer and wider each time another upstream or downstream intermediary is added.

Although each added-

participant offers new capabilities to be leveraged, the complexities involved in coordinating data, information and material flows between value stream participants increase as well. Consider the value stream shown in Figure 3-3.

Note that numerous

data/information flows and material flows are involved, and that all of these flows occur between adjoining participants. Each participant determines demand forecasts from data and information provided by only the most adjacent participants. Without access to consolidated data from all participants in a value stream, these forecasts tend to be error-prone, erratic and worsen over time. Participants experiencing high levels of demand uncertainty often suffer late deliveries, overstocking, high expediting costs, stressed employees, dissatisfied customers, and lost revenue. Figure 3-3 Conventional Value Stream

Tiered Suppliers Contract Manufacturers

Assemblers

Data & Information Flows

Producer

Distributors

Material Flows

Retailers Consumers

56

Value stream participants developed tactics to deal with demand uncertainty, the two most common being vertical integration and stock holding. With vertical integration, an organization chooses to do more value stream activities itself, thus shortening and narrowing its value stream. But, in doing so, the advantages gained through specialization and intermediation are lost.

With stock holding, an

organization builds up various kinds of inventories, thus providing buffers that soften the effects of poor demand forecasts. But, in doing so, higher inventory costs arise that can lead to higher prices (stressing consumer demand) and/or lower profit margins. Era 2 digitalization provided a much better way to cope with the challenges of long and wide industry value streams. Figure 3-4 depicts a platform-enabled value stream. In general terms, a platform uses digital technologies to host digital and digitally-enabled resources. In this case of a value stream platform, these hosted resources are likely to include: digitized data and documents, digitalized managerial and operational processes that operate on these data/documents, tools for analyzing data, and tools enabling employees from participating organizations to interact and collaborate. By using the resources available through value stream platforms, value stream participants can: better plan their own work activities; better plan and then coordinate the data, information and material flows that permeate a value stream; and, collaborate to resolve problems that arise.

57

Figure 3-4 Platform-Enabled Value Stream Tiered Suppliers

Contract Manufacturers Assemblers Producer

Value Stream Platform  Data/Documents  Processes  Analytic Tools  Collaboration Tools

Distributors Data & Information Flows Retailers Material Flows

Consumers

Many successful value stream platforms have been built, owned and managed by powerful value stream participants.

Classic examples include Dell’s

platform for executing its build-to-order business model (see Figure 3-5) and Enterprise Rent-A-Car’s platform for executing its repair rental car business model (see Figure 3-6). Considerable efforts have been taken by industry consortiums, (e.g., electronics manufacturing, automobile manufacturing, chemical production, etc.), to define and implement platforms to be used across the varied value streams that comprise these industries’ market ecosystems.

58

Figure 3-5 Dell’s Value Stream Platform

Data & Information Flows Product & Material Flows

Inbound (Upstream) Logistics Providers

Outbound (Downstream) Logistics Provider

Contracted Assembler

Component Suppliers & Contract Manufacturers

Dell’s Value Stream Platform

Consumer

Dell

Figure 3-6 Enterprise Rent-A-Car’s Value Stream Platform

Data & Information Flows

Insurance Companies

Enterprise Rent-A-Car

Enterprise’s Value Stream Platform

Consumer

Auto Repair Shops

Omni-Channel Promotion, Ordering and Delivery As Era 2 progressed, advances with WWW technologies accelerated, increasing the functionality, ease-of-use and availability of value stream platforms. One of the key targets of platform enhancement involves the variety of channels used for 59

promotion, ordering and delivery activities (see Table 3-4). As a consequence, value stream participants enlarged the portfolio of channels through which participant interactions occurred. Such interactions involve data, information and/or material flows between: 

Participants’ digitalized processes (e.g., a producer’s component ordering system interacts with a supplier’s sales order processing system).



Participants’ employees (e.g., a producer’s purchasing clerk interacts with a supplier’s customer support representative via a series of texts).



A participant’s digitalized process and another participant’s employee (e.g., a producer’s purchasing clerk interacts with a supplier’s order tracking system).



A participant’s digitalized process and an individual consumer (e.g., a consumer interacts with a producer’s online storefront).



A participant’s employee and an individual consumer (e.g., a consumer interacts with a producer’s customer support representative via an online chat capability).



Two (or more) individual consumers (e.g., two consumers interact through a producer’s online customer forum). Table 3-4 Value Stream Participant Interaction Channels

Medium

Mass

Personal

Social

Era 1 Channels Ordering & Promotion Delivery

Era 2 Channels Ordering & Promotion Delivery

Radio Television Print Magazines Newspapers Catalogs Direct Mail

Retail Store

Internet Ads Producer Website Retailer Website Informational Websites Posted Reviews Messaging email/text

eCommerce B2C B2B

Telephone Face-to-Face

Mail Services Parcel Services Telephone Face-to-Face

Search-Targeted Ads Messaging email/text/chat

Messaging

Group Event

Group Event

Social Media Groups Messaging Interactions Targeted Ads Blogs

Avon Tupperware

60

Payment and Trust Systems The accelerating growth of B2C e-commerce witnessed innovations in both payment systems and trust systems. Purely-digital alternatives, such as PayPal and Amazon’s 1-Click, have emerged in response to consumers’ desire for more accessible and convenient payment systems for online transactions.

Similarly,

innovations were targeted at increasing consumers’ willingness to engage with ecommerce retailers (e.g., third-party institutions such as VeriSign) and to purchase products on a sight-unseen basis (e.g., consumer reviews). Consumer reviews, in particular, have become a culturally-accepted trust mechanism, despite concerns14 about fake reviews and a tendency for contributed reviews to possess a sociallyinfluenced bias toward positive ratings. Era 3 Era 3 digitalization emerged largely as a consequence of the coming together of smart devices, value-unit social media complements and pervasive connectivity. A smart device refers to an assembled piece of digital technology (e.g., a product, a component, a tool, an accessory, etc.) that provides a digital capability to sense, analyze and act on environmental signals. Table 3-5 describes some familiar but, in contrast to what is happening today, not-so-smart smart devices. Value-unit social media complements refer to the opportunities made available to value-unit consumers to engage with the value-unit’s producer and/or retailer and with other consumers via social media.

Pervasive connectivity is a characteristic of an

S. Aral, “The Problem with Online Ratings,” Sloan Management Review, Winter 2014, pp. 47-52. 14

61

ecosystem

where

collections

of

smart

devices

across

the

ecosystem

are

interconnected, thus creating opportunities for anywhere, anytime interaction; these interactions contribute (e.g., sensed data, novel ideas, reviews, etc.) significantly to business model value propositions. How are individuals (typically, employees and/or consumers) motivated to contribute to the ecosystem?

While (direct or indirect)

monetary payment has traditionally been a dominant primary mechanism, alternative mechanisms - reputation and social capital - are proving to be equally, if not more, effective. Table 3-5 Some Familiar Smart Devices Device

What is Sensed

What Action is Taken

Smartphone

Screen icon touch

An app is launched

Home Thermostat

Ambient room temperature

Furnace (air conditioner) turned on when ambient temperature too low (high)

Tire Pressure Sensor

A tire’s current air pressure

Dashboard icon lights up when the tire’s air pressure is too low

Smart Refrigerator

The condition of a refrigerator’s water filter

A display icon lights up when the water filter needs to be changed

Satellite signals indicating the coordinates of the unit’s geographic location

An icon is positioned on a displayed digital map that indicates the vehicle’s position, direction & speed

Shipment Unit Packaging Sensor

The force exerted on a shipped unit if and when the unit shifts or drops while in transit

If sufficient force is detected, the shipped unit is returned to the point of origination for damage assessment

Electronic Device FaultDiagnosis

Temperature of the device

A series of pre-programmed tests are performed on the device’s circuitry

Vehicle Navigation GPS Unit

The pervasive connectivity of smart devices can produce huge volumes of streamed data, popularly referred to as Big Data, to be captured, organized and analyzed.

Era 3 digitalization enables value stream participants to: maintain an

awareness of targeted events occurring across a value stream, as well as within adjacent value streams; to capture data about these events; and, to apply statistical 62

and mathematical models to these data in developing deeper understandings of the competitive context, of value stream participants (e.g., raw material suppliers, component suppliers, services providers, downstream-consumers, etc.), and of specific competitive situations.

Table 3-6 provides two relatively straightforward

examples of the benefits obtainable from Big Data analytics. Table 3-6 Big Data Analytics Examples City of Boston

Bicycle Pump Producer Buzz Analytics

Street Bump iPhone App

Digitalization Captured consumers’ messages on social media (Facebook, Twitter, etc.) about bicycle pumps.

Drivers turn on app and placed iPhone on car dashboard.

Analyzed messages to prioritize pump features and to identify the weaknesses of the producer’s pump vis-a-vis competitors’ pumps: less durable, hose harder to use, and contained a costly but low-ranked built-in gauge.

App captures data about potholes encountered (location, estimated depth/size, etc.) and transmits these data to a City of Boston data server.

Tearing down competitors’ products revealed higherquality components and less bulky packaging.

Captured data cleansed (e.g., non-pothole bumps filtered out) & analyzed to prepare listings of potential potholes to be filled.

Outcomes Potholes fixed before they become major road hazards and while repair costs are relatively low.

Removed pressure gauge and reduced packaging. Applied cost savings to use higher-quality components.

Recurrent potholes can signal serious road management problems.

Source D. Fedewa, G. L. Velarde and B. O’Neill, “Using Buzz Analytics to Gain a Product and Marketing Edge,” McKinsey Quarterly, Number 2, 2016, pp. 14-15.

D. O’Leary, “Exploiting Big Data from Mobile Device Sensor-Based Apps: Challenges and Benefits,” MIS Quarterly Executive, December 2013, pp. 179-187.

This capability to capture, archive and analyze large streams of transactionrelated data has made viable a new trust mechanism: self-regulation. With selfregulation, an organization captures data associated with critical market-related transactions, monitors these data for problems, reacts responsively and responsibly if (and when) problems arise, and keeps (governmental or third-party) regulators and value stream participants aware of these activities.

63

The Promise of Car Data15 To catch a glimpse of what is on the horizon as Era 3 progresses and intensifies, let us take a not-so-futuristic look at how Big Data analytics is changing automotiverelated competitive contexts. During the coming decade, technology entrepreneurs and digital giants are expected to partner with incumbents in the automotive industry to exploit an expected surge in the availability of car data and to introduce innovative car-related features and services for which consumers are expected to be very willing to pay. What exactly is car data?

A short list would include data about: the road and

environmental conditions, the status of a car’s various components (e.g., engine, battery, tires, etc.) and systems (e.g., power, steering, safety, etc.), vehicle usage history

(e.g.,

speed,

direction,

location,

past

and

current

trips,

etc.),

driver/passenger personal data and preferences, and direct communications from the vehicle (e.g., phone, text, email, calendar, social media, etc.). At present, a key unknown is: “Will most people be willing to share this information for free?” Most observers feel the answer will be Yes given the immediate benefits to be derived by a vehicle’s driver and passengers (see Table 3-7). What do you think?

This section is based on material from: D. Mohr, G. Camplone, D. Wee, T. Moller and M. Bertoncello, “Car data: Paving the Way to Value-Creating Mobility”, McKinsey Quarterly, March 2016: https://www.mckinsey.de/files/mckinsey_car_data_march_2016.pdf 15

64

Table 3-7 Immediate Driver/Passenger Benefits from Sharing Car Data Safety  Real-time emergency calls  Early on-scene accident reporting  Information to support rescue services  Real-time road hazard warning

Time  Reduced travel time through optimized routing, navigation & traffic management systems  Reduced time to locate parking through connections with parking services

Convenience  Reduced breakdown risk and vehicle downtime through predictive maintenance and connections with repair & spare parts service providers  Concierge services (refueling, carwash, in-trunk delivery)  Overall, a more-connected lifestyle

Cost  Reduced insurance cost through pay-as-you-drive insurance schemes  Reduced toll/road tax rates through an automated payment infrastructure

Why is this scenario so appealing to ecosystem participants? The answer lies in both sides of the profit model component of a business model: generating revenue and reducing cost. New sources of revenues include: selling or leasing new products and services to car owners, leveraging car data with other sources of data to push tailored advertisements to drivers and passengers, and selling/leasing curated car data to third-parties. New means of cutting costs involve creative uses of car data and car connectivity to reduce the R&D, production, delivery and marketing costs associated with automobile-related products and services.

In essence, the

connected-car is increasingly being seen as the first step into the store and, when combined with autonomous driving, as a prime space for retail where producers and retailers directly interact with a captive consumer. Disintermediation, Reintermediation and Intermediary Transformation Over the last two decades, digital disruption has introduced seemingly constant participant turnover into most pipeline ecosystems. Established organizations are frequently losing prominence in markets and, not infrequently, exiting markets – 65

think Borders, Blockbuster and Circuit City. Simultaneously, scores of new, highlydigitalized entrants are participating in these same markets (as well as discovering new, profitable niches in existing markets or creating entirely new markets). Today, the ever-accumulating stocks of digitalization capabilities arising from the three eras of digital disruption have seeded and continue to see radical structural changes in pipeline ecosystems. The primary drivers of these ecosystem structural changes are disintermediation, reintermediation and intermediary transformation. Disintermediation occurs when an intermediary is bypassed, thus shortening and narrowing a value stream. Reintermediation occurs with the appearance of a new intermediary,

whose

presence

lengthens

and

broadens

a

value

stream.

Intermediary transformation occurs when an existing intermediary vertically integrates, thus becoming a producer. Table 3-8 describes these structural changeevents for the upstream and downstream segments of pipeline ecosystems. Below, we provide examples of each type of change-event for the downstream context.

66

Table 3-8 Value Stream Structural Change-Events Downstream Disintermediation

Reintermediation

Intermediary Transformation

Producer bypasses intermediaries to directly engage in market exchanges with consumers. Entry of digitalized retailer, whom facilitates market exchanges between producers & consumers. Entry of digitalized infomediary (an intermediary dealing solely with data & information), whom identifies sought value-units and/or producers to consumers. Intermediary integrates backwards to become a producer creating & delivering valueunits to consumers.

Upstream Disintermediation

Producer bypasses intermediaries to directly engage in market exchanges with raw material suppliers, component suppliers and/or service providers. Supplier bypasses intermediaries to directly engage in market exchanges with producers and/or bypasses producers to directly engage in market exchanges with consumers. Entry of digitalized distributor facilitating market exchanges between producers & raw material suppliers, component suppliers and/or service providers.

Reintermediation

Intermediary Transformation

Entry of digitalized infomediary identifying sought raw materials, components & services, as well as suppliers/providers, to producers. Intermediary integrates backwards to become a producer, creating and delivering valueunits to suppliers, intermediaries, producers and/or consumers.

Almost all producers in consumer markets (e.g., clothing, shoes, digital devices, furniture, grocery products, art, music, etc.) are disintermediating, to varying extents, their downstream ecosystem via a B2C sales channel. B2C channels provide many benefits – most are obvious, but some are not-so-obvious - to producers and to consumers.

Producers enjoy: a new revenue-generating sales

channel complementing, rather than cannibalizing, existing sales channels; higher profit-margins on B2C sales, especially with overstocked items; the opportunity to directly touch and interact with consumers, building loyalty and engagement; and, the opportunity to indirectly and directly involve consumers in new product development activities. Consumers enjoy: access to a producer’s entire product line and to product-support content; immediate, and often early, access to a producer’s new and overstocked products; the ability to express feelings of satisfaction and 67

dissatisfaction directly to a producer; opportunities to engage with the producer and with other consumers in learning about a product and product-related activities; and, opportunities to influence a producer’s next generation of products.

Who loses?

Clearly, the intermediaries, i.e., distributors and retailers, who have been partially or fully disintermediated. As described in Table 3-8, there are two primary reintermediation pathways with downstream ecosystems: the entry of a digitalized intermediary and the entry of a digitalized infomediary. An infomediary is a digitized intermediary that gathers content from across the WWW, curates the content and provides access to this curated content. Amazon’s foray into the retail marketplace for books is the iconic example of a digitalized entrant serving as disruptive intermediary, and Google’s reshaping of Internet search is the iconic example of a digitalized entrant serving as a disruptive infomediary. Finally, highly-capable and influential intermediaries able to develop deep knowledge of a pipeline ecosystem may be able to exploit this knowledge to become a producer of the value-units being delivered to consumers. Two examples nicely illustrate the breadth of possibilities.

Netflix successfully disrupted the pipeline

ecosystem for film and television video not once, but twice: first as a partiallydigitalized intermediary renting DVDs, and later as a fully-digitalized intermediary streaming video provider. Now, Netflix is producing and delivering its own content, strengthening its ecosystem influence such that the company is universally recognized both as one of the industry’s more powerful and innovative players. Amazon, on the other hand, has followed two very different paths in becoming a producer.

Having by necessity developed (1) deep knowledge of the pipeline 68

ecosystem that creates and delivers books to consumers and (2) strong digital capabilities as this ecosystem transitioned from hardcopy to digital books, Amazon has become a successful publisher of digital books through its Kindle Direct Publishing operation. Again, having by necessity developed superb digitalization capabilities in executing its massive B2C and B2B business models, Amazon has also become a successful provider of digitization services (e.g., computer processing power, data storage, content management, etc.) through its Amazon Web Services operation. A Recap and Look Ahead This chapter has both explained the economic foundations that have enabled pipeline ecosystems to dominate most industries over the past century and the manner

by

which

digitization

and

digitalization

have

transformed

pipeline

organizations and pipeline ecosystems over the three eras of digital disruption. Given this understanding of pipeline ecosystems, the next chapter examines digital strategy formulation and evolution for pipeline organizations.

69

Chapter 4. Digital Strategy Formulation for Pipeline Organizations

Today, most of the data and documents that move between and within value stream participants in a pipeline ecosystem, as well as most of these participants’ operational and managerial processes, are extensively digitalized.

As a result,

digitized data and documents can be quickly accessed, absorbed and shared, reassembled for new uses, and analyzed to produce specific answers, fresh insights and reports. Digitalized processes can be quickly executed, incrementally or radically modified, adapted to new contexts, and analyzed to recover the knowledge embedded within a process’s logic.

Importantly, the greater the extent of

data/document digitization and of process digitalization, the easier it becomes for an organization’s leadership team to display adaptive and entrepreneurial agilities. This chapter builds upon the earlier ideas provided on digital strategy fundamentals and on pipeline ecosystems by providing insights about the digital strategy formulation for pipeline organizations. It covers the following topics: 

Digitalization and the Value Disciplines



Platform Design



Platforms and the Domains of Digitalization



Digital Strategy Formulation



Digital Strategy Formulation in Practice



Sustaining Held Competitive Positions

Digitalization and the Value Disciplines Value disciplines are incorporated within an organization’s digital strategies through a collective mindset and capabilities for execution.

Today, many of the 70

needed capabilities are provided through the technical services being hosted on digital platforms and through the operational and managerial business processes being hosted on business platforms. Invariably, a business platform makes use of multiple digital platforms. Table 4-1 sums up how the engines of digitalization (automation, control, empowerment and interaction) can enhance business processes associated with each of the three value disciplines. Two significant trends regarding digital strategies are reflected in just such investments in digitalized business platforms. Table 4-1 Enhancing the Value Disciplines via Digitalization Digitalization Engine

Automation

Control

Empowerment

Interaction

Value Discipline Operational Excellence Upstream, midstream & downstream work activities handled quickly, accurately & completely in a lesscostly, more-timely manner.

Customer Intimacy Availability of a broad range of media channels through which customers are touched.

Product Leadership R&D, product commercialization, quality assurance & after-sales support work activities handled quickly, accurately & completely in a less-costly, more-timely manner.

Fewer suboptimal actions Digitalized business taken and quicker sensing of solutions & employees exceptional or changed touching customers produce situational contexts. fewer suboptimal results.

Digitalized business solutions & employees engaged in R&D, product commercialization, quality assurance & after-sales support produce fewer suboptimal results.

Employees engaged in operational/managerial work produce fewer poorlyinformed or ill-informed results.

Employees touching customers are better informed about the customer and the situation.

Employees engaged in R&D, product commercialization, quality assurance & after-sales support are better informed.

Digitalized business solutions & employees engaged in work activities exchange more & better data & information.

Customers & customer communities can be engaged across time and space.

Employees engaged in R&D, product commercialization, quality assurance & after-sales support can engage one another, employees of strategic partners & customer communities.

First, well-architected digitalization helps firms develop both adaptive and entrepreneurial agilities.

As more competitors in a market-focused ecosystem

demonstrate these agilities, the pace at which organizations must implement and respond to competitive actions quickens dramatically. Since the competitive actions 71

taken by competitors emphasize differing value disciplines, organizations striving to gain a competitive advantage or maintain competitive parity are increasingly forced to target multiple value disciplines.

Vivid examples of this phenomenon were

provided in Chapter 2’s discussions of General Electric and Apple. Second, many of the core capabilities needed for organizations to achieve competitive parity are increasingly available from technology providers in the form of pre-packaged business platforms.

Digitally-savvy organizations can quickly

acquire a business platform, integrate the acquired platform within its installed assemblage of digital platforms and business platforms, and competitively exploit this expanded set of capabilities. Essentially, such practices find organizations innovating by imitating other firms’ innovations – a much-faster and less-risky form of innovation.16 However, such practices only serve to further speed up the pace of competition within market-focused ecosystems. Platform Design Well-architected platforms are the means by which organizations are able to evolve their business models and execute competitive actions in a timely manner. But, what exactly is meant by a well-architected platform?

A well-architected

platform exhibits an appropriate balance in (1) the stability and agility of the hosted functionality and (2) the costs of building, enhancing and extending platforms across functional, unit and organization boundaries. In order to fabricate a well-architected platform, three design issues must be addressed: modularity; tight-coupling vs. loose-coupling; and, global vs. local.

O. Shenkar, Copycats: How Smart Companies Use Imitation to Gain a Strategic Edge, Boston: Harvard Business School Publishing, 2010. 16

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Modularity With modularity, each of a platform’s major functionalities, or modules, operates independent of other functionalities and obtains needed information or resources from a common coordinating module. Therefore, it is easy to add modules to or remove modules from the platform. Additionally, once a platform is built, it is relatively easy to modify any of the platform’s modules. Tight-Coupling and Loose-Coupling Tight-coupling and loose-coupling refer to the nature of the interconnections that enable data, messages and documents to be exchanged between platforms. With tight-coupling, one or both of the interconnected platforms are modified so that the data, messages and/or documents being exchanged are consistently interpreted across both platforms. Because the required modifications require both time and effort, tight-coupling can be very intrusive for one or both of the platforms. With loose-coupling, one of two tactics is generally applied: 

Some form of interconnection component is used to translate the data, messages or documents flowing from one platform to the other platform. While time and effort is required to devise the translation rules, once devised the rules can be applied to facilitate exchanges of the data, messages and/or documents with other platforms.



The functions being executed on each of the platforms conform to the same set of data/message/document standards (often established by an industry association or by a consortium of powerful industry players). While time and effort are initially required to negotiate standards and conformance policies, platforms hosting ‘standards-compliant’ functions are relatively easy to interconnect.

Both of the loose-coupling tactics are far less intrusive than tight-coupling. Figures 4-1 and 4-2 contrast tight-coupling and loose-coupling. In general, tight-coupling can provide for greater stability (being seamless and using less 73

complex technology, it is easier to harden and secure) and loose-coupling can provide for greater agility (both the platform and its connections to other platforms are easier to modify). In terms of cost, initial connection costs are greater with loose-coupling, but subsequent connection costs tend to be less. Figure 4-1 Tight-Coupling and Loose-Coupling

data, messages, documents

Tightly Coupled

Module A

Module B

data, messages, documents

Loosely Coupled

Module A

• Interconnection

Artifact

Module B

• Agreed-to Standards

74

• • • •

Seamless Less Complex Technologies More Intrusive Best for a One-to-One connection

• • • •

Interceded More Complex Technologies Less Intrusive Best for a One-to-Many Connection

Tightly-Coupled

Loosely-Coupled

Figure 4-2 Contrasting Tight-Coupling and Loose-Coupling

Global and Local The term global, as used throughout this book, refers to a digital solution that is designed and built to be used by most of an organization’s work units (another term often used to connote a global digital solution is enterprise-wide). A local digital solution is designed and built to be used by one or only a few of an organization’s work units. Figure 4-3 summarizes the advantages of global and local platforms. Global platforms are more cost-effective to build, support and modify because associated costs are spread across a large base of users. Additionally, the digital solutions that comprise global platforms are highly-leverageable, as these solutions can be reused as new functionalities are appended to a platform. However, considerable time and effort is required to negotiate the design of and to implement global platforms (as well as subsequent modifications to global platforms).

Further, it is all too often 75

infeasible to use global platform functionalities to meet a work unit’s needs (e.g., a functionality unique to the work unit, an innovative functionality, an extremely quick response to an identified opportunity or problem, etc.). In such situations, fashioning and implementing a local platform is more effective and timely. That said, an overdependence on local platforms can quickly lead to excessive costs: work units undertake digitization and digitalization projects to gain functionalities that have already been built by other work units; and, when reuse tactics are followed, unforeseen complexities invariably arise when integrating and/or interconnecting independently-designed digital solutions.

• • • •

Tailored Solutions Innovative Solutions Timely Solutions More-Easily Implemented Solutions

• Lower-Cost Solutions • Leveraged Solutions • More-Easily Supported & Modified Solutions

Local Platform

Global Platform

Figure 4-3 Contrasting Global and Local Platforms

Platforms: Best Practices It is increasingly accepted that organizations’ platforms, ideally, should be modularly-designed and that optimal balance should be achieved regarding these 76

platforms being tightly/loosely coupled and being implemented as a global/local resource. Although platform modularity is a key feature of newly-built and acquired platforms, most organizations are in the midst of extensive (and expensive) journeys to re-architect their installed platforms. Achieving an optimal balance in the use of tight-/loose-coupling is an ongoing endeavor for most organizations – an endeavor having two overarching design rules: 

If a platform is expected to be frequently adapted, then loose-coupling is used to incorporate a bias toward dynamism.



If a platform is expected to be infrequently adapted, then tight-coupling is used to incorporate a bias toward stability.

Achieving an optimal balance in the use of global and local platforms is an ongoing endeavor for most organizations. However, most organizations have a bias toward global platforms, with a few exceptions: 

Digitalized functionalities expected to serve a single work unit (or a few work units) should be implemented as local platforms.



Digitalized functionalities that must be implemented quickly for competitive reasons should be initially implemented as local platforms (to avoid having to follow constrained and time-consuming design and implementation policies and processes for global platforms) and then, once proven and stabilized, be considered as candidates for reimplementation as global platforms.



Digitalized functionalities that apply unproven solutions or that introduce novel forms of digitalization should be initially implemented as local platforms (to contain risk) and then, once proven and stabilized, be considered for reimplementation as global platforms.

Platforms and the Domains of Digitalization Today, platforms host most of the capabilities enabling organizations to carry out day-to-day work activities and undertake competitive actions.

This section

77

describes

how

digital

platforms

and

business

platforms

have

transformed

organizations’ operational, analytical and collaborative domains. The Operational Domain Digitalization of the operational domain is directed at two primary aims: event visibility and channel multiplicity. Event visibility refers to making key events (an order, a sale, an inventory movement, a shipment movement, a shipment delay, etc.) and non-events (a consumer leaving without a purchase, an out-of-stock inventory situation, etc.) known to the individuals and the digitalized solutions taking action so that appropriate actions can be taken. Currently available digital technologies have overcome many of the challenges that previously restricted event visibility. However, it is important to recognize that event visibility is also affected by cultural practices. If an organization’s work units are insufficiently incentivized to work together, it can be difficult to get all employees to dance to the same song. Sales personnel, for example, tend to be rewarded for sales growth, while manufacturing personnel tend to be rewarded for productivity and quality control. As a result, manufacturing personnel may decide not to let sales personnel know about a spike in defect rates – information that the sales unit needs when interacting with customers. Such issues only intensify with information flows that cross organizational boundaries. Should a manufacturer let a supplier know the nuances that underlie customers’ purchasing behaviors? How about if the supplier also supplies the manufacturer’s prime competitors? Should a component-supplier let a manufacturer-customer know about an emerging supply chain issue likely to delay future component shipments? Does your answer change if the manufacturercustomer could easily switch to other suppliers? 78

Channel

multiplicity

refers

to

ensuring

that

a

sufficient

mix

of

interconnection channels are available to handle the data, messages and documents flowing to and from individuals and digital solutions so that a preferred channel is available for use. Channel multiplicity is particularly important when connecting with humans, as people tend to develop strong preferences for using specific channels for different interconnection situations. Consider your own behavior, for instance. Do you communicate most with others who use the same communication channels (e.g., email, texting, phone, etc.) that you prefer?

Do you tend to use specific

communication channels for communicating specific types of information (e.g., texting for good news, but speaking face-to-face for bad news, or vice versa)? Figure 4-4 depicts a generic operational platform. Note that the platform hosts an organization’s primary and support processes, as well as the data captured and used by these processes. Further, these processes extend externally to connect with the processes of value stream participants through a mix of interconnection channels. It is by appropriately tuning these processes and by using appropriate interconnection channels that key events occurring inside and outside an organization are made visible to individuals and digital solutions.

79

Support Processes

Primary Processes

Channel Multiplicity

Global Operational Database

Channel Multiplicity

Material & Component Suppliers

Channel Multiplicity

Upstream Intermediaries

Channel Multiplicity

Figure 4-4 A Generic Operational Platform

Downstream Intermediaries

Consumers

The operational domain is especially important for passenger airlines, such as Delta Airlines.17 Consumers are very concerned with safety, with on-time departures and arrivals, and with having their in-flight needs met. Not surprisingly, all airlines pursue the operational excellence value discipline. Figure 4-5 provides a high-level view of Delta’s operational platform. Operating a heavy schedule of flights across a mix of aircraft, routes and airports is like choreographing and directing the largest ballet ever conceived. Unless all employees and all executing digitalized solutions are collectively able to maintain a close-to-real-time awareness of the thousands of events occurring each minute, problems are sure to arise.

This discussion of Delta’s operational platform is adapted from material in: J.W. Ross, P. Weill and D.C. Robertson, Enterprise Architecture as Strategy, Boston: Harvard University Press, 2006. 17

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Figure 4-5 Delta Airline’s Digitalized Operational Platform

Location Schedule

Flight

Employees

Equipment

Maintenance

Aircraft

Customer

Core Data

Ticket

Allocate resources Prepare for flight departure Load aircraft Flight departure & closeout Monitor flight Flight arrival & closeout Unload aircraft Clean & service aircraft

Primary Processes

The Analytical Domain Digitalization in the analytical domain is also directed at two primary aims: improving decision processes, and accumulating knowledge about these decisions to improve operational and managerial performance. Organizations amass analytical capabilities by providing (suitably-trained) employees with easy-to-use tools with which to access and analyze comprehensive collections of data. Increasingly, subsets of these same analytic capabilities are provided to employees of other value stream participants (e.g., a retail chain’s buyers, a supplier’s manufacturing management team, etc.). Figure 4-6 depicts a generic analytical platform. Collections of data typically reside in either a data warehouse (a single, comprehensive archive of organized data across multiple spheres of work; e.g., marketing, logistics and manufacturing) 81

or a more focused data mart (a smaller archive of organized data focused on a specific sphere of work; e.g., marketing, logistics or manufacturing). These data archives are populated from operational databases, from other internal sources, and from external sources

(e.g., market

research firms, economic forecasters,

governmental agencies, etc.). Furthermore, these data are most often analyzed to achieve one or more of the following four purposes: description, diagnosis, prediction or prescription. The most common analytical tools used in achieving these purposes are defined in Table 4-2. Figure 4-6 A Generic Analytical Platform External Data Sources

Data Warehouse and/or Data Marts

Ad Hoc Queries

Predefined Queries

Global Operational Database

Other Internal Data Sources

Description  Events  Objects  Situations

Diagnosis  Failure  Success  Event occurrences

Analytic Purpose Prediction  Events  Outcomes

Prescription  Optimal actions

Statistical Analyses

Math. Modeling

Data Mining

Machine Learning

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Table 4-2 Common Analytical Tools Analytic Tool

Description

Ad Hoc

Data retrieval via user-generated search criteria & display formats. Data retrieval with pre-defined search criteria & display formats. Descriptive (organizing and summarizing data to better understand the data) & inferential (confidently drawing conclusions from samples of data). Combining large amounts of data and sophisticated algorithms to make accurate predictions and to derive optimal solutions to complex problems.

Queries Predefined Queries Statistical Analyses Mathematical Modeling

Discovery of patterns within sets of data that lead to Data Mining & insights regarding the relationships amongst these Machine Learning data.

The analytical domain is important for organizations tailoring value-units for consumers - especially for a customer-intimacy company like Netflix that strives to provide subscribers with a customized, fresh experience each time they access the Netflix content catalog. Figure 4-7 provides a high-level view of Netflix’s digitalized analytical platform.

Netflix has fashioned a huge data archive from three major

sources: subscriber-provided data (a self-profile and content ratings), content data (largely put together by Netflix staff), and real-time data streams capturing verydetailed views of subscribers‘ content-viewing behaviors. By analyzing these data via numerous proprietary algorithms, Netflix is able to optimize the content recommendations and viewing experiences provided to each subscriber (increasing engagement and decreasing cancellation likelihood) and is able to make moreinformed decisions about buying, licensing and producing content.

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Figure 4-7 Netflix’s Digitalized Analytical Platform

Subscriber Real-Time Viewing Behaviors

Subscriber Profiles Subscriber Content Ratings

Content Attributes (genre tags, technical data, artist data, etc.)

Core Data

Predicting & prescribing a subscriber’s content selections. Diagnosing & predicting actions of subscriber segments. Prescribing content types/amounts for the current content catalog. Prescribing how content should be stored & delivered to provide the best subscriber experience.

Critical Analytic Processes

Prescribing content to acquire, license & produce.

The Collaborative Domain Digitalization in the collaborative domain involves the fabrication of interaction platforms through which people are brought together virtually, rather than physically, to jointly accomplish work activities. Such a capability is becoming increasingly important in today’s highly-competitive, far-flung markets. Often, the best people to bring together to solve a problem or to tackle an opportunity are employed by participants across a value stream (see Table 4-3).

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Table 4-3 Value Stream Collaboration Opportunities Collaboration Opportunity Downstream Processes

Upstream Processes

Description Employees from manufacturers, distributors & retailers collaborate to better understand consumer demand patterns, to develop joint strategies & tactics for marketing & fulfillment, and to detect & resolve downstream supply-demand imbalances. Employees from manufacturers, raw material & component suppliers, and upstream intermediaries collaborate to better understand procurement & production patterns & costs, and to detect & resolve upstream supply-demand imbalances.

Upstream & Downstream Logistics

Employees from manufacturers, suppliers, subcontractors, distributors, retailers & logistics providers collaborate to better understand transportation demand patterns & costs, to develop joint strategies & tactics regarding transportation solutions, and to detect & resolve upstream/downstream logistics problems.

Product & Process Design

Employees from manufacturers, suppliers & engineering design firms collaborate to better understand the nature, timeframes & costs of new product/process designs, to develop joint strategies & tactics for enhancing design processes, and to detect & resolve design problems.

There are two basic types of collaboration arrangements. The first involves recurrent collaborations where the (more or less) same people work on an ongoing task (e.g., a marketing group consulting with sales teams, a weekly meeting of a manufacturer’s plant managers, etc.). Typically, a local collaboration platform is configured and used to support a recurrent collaboration. The second type of collaboration arrangement is ad hoc and temporary in nature (e.g., a task force brought together to accomplish a one-time task). Generally, groups engaged in ad hoc collaborations use global collaboration platforms, with a group’s interactions facilitated (initially and perhaps longer) by a collaboration specialist. Figure 4-8 depicts a generic collaboration platform. Each participant has access to their own digital resources in addition to the resources provided via the collaboration platform. The platform contains a data archive that holds data and documents uploaded by the participants as well as data, messages and documents that are created as participants interact within the various work spaces provisioned 85

through the platform. Figure 4-8 identifies four such work spaces: messaging and conferencing, idea processing, joint-work and decision making. Figure 4-8 A Generic Collaboration Platform

Person

Data Archive

Person Messaging & Conferencing

Person

Person

Idea Processing  Generation  Curation  Refinement

oint Spaces Collaboration Joint-Work  Designing  Problem Solving  Authoring

Decision Making

Collaboration platforms are especially important for organizations pursuing the product leadership value discipline, as new product development often requires the bringing together of dispersed expertise. A nice example of this can be seen with the exceptional outcome attained in a project undertaken by Boeing-Rocketdyne, the major U.S. manufacturer of liquid fuel rocket engines, to produce a next-generation rocket engine.18,19 The project team consisted of eight individuals (a project team leader, a concept designer, a combustion analyst, two thermal analysts, a

A. Malhotra, A. Majchrzak, R. Carman and V. Lott, “Radical Innovation without Collocation: A Case Study at Boeing-Rocketdyne,” MIS Quarterly, June 2001, pp. 229-249. 19 In 2005, Boeing sold the Rocketdyne Division to United Technologies Corporation, which sold the Division to GenCorp in 2013, which merged with Aerojet to form Aerojet Rocketdyne. 18

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manufacturability engineer, a CAD (computer-aided design) specialist, and a stress analyst) from Boeing-Rocketdyne and two partner-companies.

These individuals

were located at different geographic locations as a result of a selection process aimed at getting the very best talent available involved in the project. The project lasted for ten months with participants devoting less than 15% of their work time to the project. Participants met physically only twice: six of the eight participants were able to get together for a project kick-off meeting (that also included training on the collaboration tools) and all eight members were able to physically meet for a project-ending celebration. Table 4-4 describes the collaboration tools made available to the project team. The engine design that was produced far exceeded expectations, e.g., the rocket’s thrust chamber had only six parts (compared to the typical 1,200 parts) and a first-unit production cost of $47,000 (compared to the typical $4,500,000). Table 4-4 Next-Generation Rocket Engine Project Collaboration Tools

Collaboration Tool

Description

Shared work space enabling project team members to create, comment on, reference links Internet Notebook to, search & sort entries whose content consists of text, templates, sketches, images and/or hot links to desktop applications. Shared workspace enabling project team Electronic Whiteboard members to have near-instantaneous access to the same materials. Project Vault Email Telephone Voice Conferencing

Shared data archive enabling project team members to store & access files via a common file server. Available digital communication channels enabling project team members to interact with one another.

87

Digital Strategy Formulation Table 4-5 presents the overarching strategic challenges that need to be constantly addressed by pipeline organizations’ digital strategists as these strategists cope with digital disruption. The first of these strategic challenges addresses how to handle heterogeneity within the consumer community, which is especially important for this section’s treatment of digital strategy formulation.

If distinct consumer

segments exist and if each segment varies significantly in how it relates to valueunits and associated value propositions, then each segment is likely to require its own business model. While some of these business models might be expected to demonstrate considerable similarity, others undoubtedly will not.

This section’s

treatment of digital strategy formulation focuses on the design and evolution of a single business model, with this business model targeting either a homogeneous consumer community or one of the segments of a heterogeneous consumer community. Most often, digital strategists are involved with formulating and evolving multiple business models.

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Table 4-5 Pipeline Organization Strategic Challenges Strategic Challenges

Key Issues

How differentiated is the consumer community?

 Have we segmented, through analytics, the consumer community?  Is a distinctive business model required for each segment?

How can our current competitive positions be improved?

 How can we enhance our customer value proposition and our profit model?  Should we deepen & broaden our core capabilities and our dynamic capabilities?  To what extent can we further exploit the capabilities of value stream participants?

Can we enter an adjacent market by replicating a currently-executing business model?

 Which adjacent markets are most susceptible for one of our currently executing business models?  What type of business model modifications would be required to gain a favorable competitive position in the adjacent market?

Can we create a new market through business model innovation?

 Is it possible to apply our capabilities along with our strategic partners’ capabilities to create an innovative business model that creates a new niche within an existing market or a new market?

How can we sustain successful market positions?

 Can we deter (for some period of time) competitors’ responses to our competitive actions?  Can we keep our business models two or more steps ahead of those of our competitors?

Figure 4-9 provides an overview of the factors driving digital strategists’ deliberations as they deal with the remaining four strategic challenges listed in Table 4-5: deliberations framed by a strategic intent espoused by their organizations’ leadership teams and focused on the four elements of a business model.

89

Figure 4-9 Factors Driving Business Model Enhancement, Replication & Innovation  Competitors’ actions  Adjacent market business model innovations  Socioeconomic trends  Cultural trends  Consumers’ needs & desires

Strategic Intent Beliefs about:  Consumers’ needs & desires  Core capabilities  Dominant value discipline(s)

Business Model Deliberations  Value proposition  Profit model  Core capabilities  Dynamic capabilities

Business Model Enhancement, Replication & Innovation

 Installed platforms  Held digitization capabilities  New digital technologies  Others’ digitalization innovations

Strategic Intent A strategic intent represents a leadership team’s effort to make moreactionable their organizations’ vision and mission statements, which most-typically are presented in an aspirational and intentionally-vague manner. In essence, a good strategic vision answers the question: “What kind of organization do we wish to become?”; and, a good mission statement answers the question: “What must we do to achieve this vision?” Table 4-6 provides vision and mission statements for Apple and Walmart.20,21

Apple’s mission and vision statements obtained from: http://panmore.com/applemission-statement-vision-statement 21 Walmart’s mission and vision statements obtained from: http://panmore.com/walmart-vision-mission-statement-intensive-generic-strategies 20

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Table 4-6 Vision & Mission Statements for Apple and Walmart

Apple

Walmart

Vision Statement

Mission Statement

We believe that we are on the face of the earth to make great products and that’s not changing. We are constantly focusing on innovating. We believe in the simple not the complex. We believe that we need to own and control the primary technologies behind the products that we make, and participate only in markets where we can make a significant contribution. We believe in saying no to thousands of projects, so that we can really focus on the few that are truly important and meaningful to us. We believe in deep collaboration and cross-pollination of our groups, which allow us to innovate in a way that others cannot. And frankly, we don’t settle for anything less than excellence in every group in the company, and we have the self-honesty to admit when we’re wrong and the courage to change. And I think regardless of who is in what job those values are so embedded in this company that Apple will do extremely well.

Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork and professional software. Apple leads the digital music revolution with its iPod and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App store, and is defining the future of mobile media and computing devices with iPad.

To be the best retailer in the hearts and minds of consumers and employees.

Saving people money so they can live better.

A good strategic intent answers the question: “What must we do specifically and now to achieve our vision and mission?” In doing so, a strategic intent provides deliberating digital strategists with a sense of purpose, direction, discovery and destiny. Invariably, as indicated earlier in Figure 4-9, a strategic intent likely involves expressions of consumers’ near-term needs and desires and of the value-disciplines to be embodied for these needs and desires to be met. Business Model Enhancement, Replication and Innovation Digital strategists’ deliberations focus on discovering and shaping business model adaptations likely to strengthen current market positions or to establish positions in new markets. By far, most formulated competitive moves are taken to strengthen a current market position. Business model enhancement, replication and innovation involve distinct competitive pursuits: 91



Business Model Enhancement: incremental changes are made to one or more of the four elements of business models.



Business Model Replication: a business model proven successful in one market is applied within an adjacent market; most often, this adjacent market is characterized by value-units, consumers and/or value streams similar to the market where the business model has demonstrated success.



Business Model Innovation: Radical changes are made to one or more of the four elements of business models or a novel configuration of these elements is fashioned; this novel business model is typically implemented within a newly-defined niche of an existing market or is used in creating a new market.

Despite the differing trajectories reflected in business model enhancement, replication and innovation, similar types of adaptations (summarized in Table 4-7) tend to be observed. Table 4-7 Business Model Adaptations

Value Propositions  Satisfy unmet needs & desires of current consumers about a value-unit and/or the delivery of the value-unit.  Satisfy anticipated needs & desires of current consumers about a value-unit and/or the delivery of the value-unit.  Identify new consumers or a more-finely segment of current consumers and satisfy the needs & desires of this newly-defined consumer segment.

Core Capabilities  Add new digitalization capabilities.  Enrich the functionality of currentlyexecuting platforms.  Add new platforms.  Harden platforms operating in environments benefiting from stability.  Modularize platforms operating in environments benefiting from agility.

Profit Models  Increase current revenue streams.  Add new revenue streams.  Reduce cost structures.  Identify new pricing mechanisms for generating revenue by delivering valueunits to consumers.  Eliminate unprofitable or less-profitable revenue streams.

Dynamic Capabilities  Modify assessment frequencies.  Modify environment scanning reach & range.  Modify digital strategists’ offensivedefensive orientation.  Modify composition of the digital-strategist group.

For the most part, the profit model adaptations are quite straightforward. The one profit model adaptation that might not be readily apparent is that involving pricing mechanisms. A pricing mechanism refers to the means by which a value92

stream participant captures its share of the value being created by the value stream. A variety of value-capture mechanisms exist, with the most common defined in Table 4-8. Often, a business model applies multiple value-capture mechanisms. Table 4-8 Different Value-Capture Mechanisms Pricing Mechanism Cost-Plus Competitor-Based Multi-Tiered

Price determined as/by … A percentage on top of cost of producing and delivering a value-unit. Calibrating against competitors’ prices for the same or similar value-unit. The number & sophistication of the features provided in a value-unit variant.

Freemium

A multi-tiered mechanism where the base (first-level) tier is free.

Bundling

The nature of value-unit aggregations provided to consumers.

Segmented

The producer for specific customer segments.

Pay-What-You-Want The consumer. Fenced The consumer selecting a price-segment and the producer after fencing Pay-What-You-Want the consumer into this segment. Demand

The real-time demand for a value-unit.

Auction

An auctioning mechanism.

Installed-Base Futures Contracting

The joint cost of an installed-base (e.g., the razor) and the use of this installed-base over time (e.g., the razor blade). The predicted demand (at a future point-in-time) for a value-unit.

The modifications to the dynamic capabilities element are not quite as straightforward. Four types of modifications were listed in Table 4-7: 

Assessment frequency – the prescribed frequency by which digital strategists deliberate on a business model or on particular aspects of a specific business model; and, the continuing-suitability of certain business models and certain business model elements.



Environmental scanning reach and range – the variety of entities (range: substitute value-units, intermediaries, suppliers, etc.) and contexts (reach: edges of a pipeline ecosystem and beyond) covered in digital strategists’ environmental scanning.



Offensive/defensive orientation – whether the primary objective of the digital strategists, as a group, is to strengthen or to protect current competitive positions.



Composition of the digital strategists group: the knowledge domains (e.g., value disciplines, core capabilities, cost structures, etc.) and constituencies 93

(e.g., producer subunits, suppliers, intermediaries, consumers, etc.) influentially represented during deliberations. Each of these modifications produces significant changes in a digital strategy group’s collective awareness of the need for and nature of business model adaptations and the effort (time, complexity and cost) associated with digital strategists’ individual and group deliberations. Digital Strategy Formulation in Practice Digital strategies implemented by Finnair and by UPS Supply Chain Solutions (UPS-SCS) are illustrative of the thought-processes exercised by digital strategists. In addition, these examples illustrate two not-uncommon trends regarding organizations’

digital

strategies:

embracing

customer

intimacy

after

having

established a reputation based on operations excellence, and actively involving consumer communities in co-creating a value proposition. Table 4-9 summarizes key business model adaptations for the Finnair and UPS-SCS episodes. Table 4-9 Business Model Adaptations: Finnair & UPS Supply Chain Solutions Organization Finnair  Offer long-haul travelers Value innovative & valued services Proposition

Profit Model

 Higher-margin market segment

 Institutionalized social media

Core use Capabilities  Individualized social media use

 Co-creation of new services

Dynamic with customer community Capabilities  Outward-looking organizational culture

UPS Supply Chain Solutions  Customized, complex solutions  Quick implementations • Higher-margin market segment • Low configuration costs • Low implementation costs  Modularized solution services  Modular architecture  Educate digital strategists on modular architecture  Deploy cross-functional teams to integrate marketing, sales & digitalization specialists  Co-creation of digitalized solutions with customer  Modify investment criteria for digitization & digitalization

94

Finnair22 Finnair is the world’s oldest, midsize airline with a unionized labor force. Like similar airlines, Finnair embodied the operations excellence value discipline. However, the company’s high fixed-costs and the influx of low-cost short-haul competitors had seriously eroded its competitive position – particularly within shorthaul markets. Exploiting the airline’s geographic advantage (the Helsinki hub provides one of the fastest routes between Europe and Asia), Finnair’s leadership team had chosen in 2009 to focus the airline on long-haul Asian routes – a market niche within which Finnair was relatively unknown. Consequently, a series of competitive actions were taken to strengthen the airline’s position in the long-haul Asian market, with a key target area being the creation of innovative services to enrich the airline’s value proposition for the long-haul consumer. Finnair’s use of social media technology (SMT) has played a key role in engaging the consumer community in co-creating these new services - and in the process enhancing the airline’s image with this consumer community. Heavy usage has occurred around blogging, Facebook and Twitter, with special attention given to integrating customer interactions across these SMTs. Importantly, both institutional (structured, tightly-moderated interactions orchestrated by Finnair employees) and individualized

(unstructured,

loosely-moderated

interactions

with

individual

consumers) SMT tactics have been applied. The outcome? Since 2009, around 300

This material is adapted from: S.L. Jarvenpaa and V.K. Tuunainen, “How Finnair Socialized Customers for Service Co-Creation with Social Media,” MIS Quarterly Executive, September 2013, pp. 125-136. 22

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meaningful ideas for new services have been generated, two of which were implemented in 2013: a book-swapping station at the Helsinki airport, and the availability of a high-quality vegetarian meal option (for business-class and economy travelers) on all long-haul flights. UPS-SCS23,24 UPS is the parent company of UPS-SCS. It was formed in the early 1990s, is positioned in a mature market for transportation solutions, and has a strong culture rooted in the operations excellence value discipline. UPS-SCS, on the other hand, was established in order to pursue a differentiation strategy by developing a wide variety of specialty services and offering its B2B consumers customized, complex and comprehensive supply chain solutions. In the early 2000s, the UPS-SCS leadership team realized that its growth was about to hit a brick wall. Two factors explained this portending crisis. First, low-cost competitors had entered the UPS-SCS competitive space and were eating away at the

low-hanging-fruit,

solutions.

i.e.,

less-complex,

less-comprehensive,

but

profitable

Second, too many of UPS-SCS’s customer engagements requiring

complex, comprehensive solutions were proving to be unprofitable because of the high-cost and lengthy lead-time required to design and implement a solution. The leadership team’s strategy to address this situation involved three objectives:

M. Lewis, A. Rai, D. Forquer and D. Quinter, “UPS and HP: Value Creation through Supply Chain Partnership,” Case 9B07D002, Ivey Management Services, 2007. 24 A. Rai, V. Venkatesh, H. Bala and M. Lewis, “Transitioning to a Modular Enterprise Architecture: Drivers, Constraints and Actions,” MIS Quarterly Executive, June 2010, pp. 8394. 23

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

Operational B2B readiness – provide the capability to quickly integrate UPSSCS services into a customized solution and to seamlessly interconnect this solution with a customer’s business platforms.



Internal services awareness – increase the working knowledge of UPS-SCS sales employees and managers about the breadth and depth of UPS-SCS service offerings and how these services could be configured together in producing customer solutions.



Customer familiarity – increase the working knowledge of UPS-SCS sales employees and solution designers about current/potential customers and the idiosyncrasies that distinguish each customer from its competitors.

Achieving these objectives involved building a number of platforms: a modularized operational platform hosting and executing the UPS-SCS portfolio of digitalized solutions; analytical platforms that organized and enabled easy access to information about services, solutions and customers; and, collaboration platforms enabling solution designers, sales staff and customers to jointly configure and implement solutions. Sustaining Competitive Positions When competitive actions strengthen an organization’s competitive position, the organization ideally desires to sustain the gained competitive advantage for as long as possible (the fifth strategic challenge listed earlier in Table 4-5). For example, after the successful implementation of a first-mover customer loyalty program aimed at identifying and retaining high-value customers, increases in market share and sales revenues are likely to be realized. However, if competitors are able to quickly imitate the loyalty program, then these initial gains are likely to dissipate as competitive parity returns to the market. Digital disruption is making it more difficult than ever to sustain a newly-gained competitive advantage. As many, if not most, of the digital platforms and business platforms enabling competitive advantages are readily available today, competitor 97

imitative responses occur promptly and frequently.

Further, as these imitative

responders can learn from the innovator’s actions, these responses are often better and less costly. The tactic taken most often to sustain a newly-gained competitive advantage is to construct one or more barriers to competitive retaliation.

The less-

penetrable these erected barriers are, the longer the competitive advantage can be sustained. Piccoli and Ives categorize these barriers into four types (see Table 410):25 digital resources, complementary resources, project management capabilities and preemption. Table 4-10 Barriers to Competitive Retaliation Barrier

Characteristics of a Strong Barrier

Digital Resources

 Unique and/or rare  Not available from a third-party  Difficult, time-consuming and/or costly to build from scratch

Complementary Resources

 Unique and/or rare  Not available from a third-party  Difficult, time-consuming and/or costly to build from scratch

Project Management Capabilities

Preemption

 Complexity of an imitative response  Difficult, time-consuming and/or costly to develop needed capabilities  High consumer switching costs  Difficult, time-consuming and/or costly to identify & attract value-stream participants and to build the platforms to coordinate value-stream data, document & information flows

The digital resources barrier is based on an organization’s investment in unique or rare digital/digitalized assets and capabilities.

For example, if an

organization has developed unique capabilities to build, operate and secure value

G. Piccoli and B. Ives, “IT-dependent Strategic Initiatives and Sustained Competitive Advantage: A Review and Synthesis of the Literature,” MIS Quarterly, December 2005, pp. 747-776. 25

98

stream upstream/downstream platforms and if a gained competitive advantage is dependent on such a capability, then it would likely take a rival a prolonged period of time to put in place similar platforms.

Just such a barrier was invoked when

Walmart pioneered vendor-managed inventory with Procter and Gamble. Walmart provided Procter and Gamble with the ability to access Walmart point-of-sale data in real-time so that Procter and Gamble could monitor Walmart’s store-level inventories and replenish stock on an as-needed basis. The complementary resources barrier is based on requirements for unique or rare non-digital resources in establishing a digitalized competitive advantage. Harrah’s, for example, has been a pioneer in using analytics to build and exploit superior customer relationships.

However, Harrah’s also undertook a radical

organizational change when it launched its customer-analytics strategic initiative. Casinos in a chain traditionally operate independent of one another.

With the

organizational change, Harrah’s introduced reporting structures and incentives to build an enterprise-wide customer relationship management culture where customers are owned by the corporation rather than by a specific casino, and where employees are expected (and rewarded for doing so) to make decisions on the basis of customerrelated analytics. Digitalized competitive actions are often implemented as large, complex and risk-laden projects involving a large number of people holding a variety of skills. Such projects can be extremely difficult to complete on-time, on-budget and as specified. The project management capabilities barrier involves the presence of needed project management capabilities. For example, when Amazon launched its B2C retail bookstore, a large number of complex activities needed to be carried out 99

well and in a highly-coordinated fashion: building the needed digital and business platforms; putting in place a powerful and reliable technical infrastructure to host its online store; establishing efficient, effective and reliable physical operational and managerial processes (e.g., warehouse operations, order packing and shipping, customer service, processes, etc.); and, negotiating relationships with value stream participants (e.g., book publishers and distributors, logistics providers, financial services firms, etc.). Any competitor would need to possess correspondingly-high levels of project management capabilities. A preemption barrier limits competitors’ opportunities and incentives to undertake retaliatory action. One such barrier involves customer switching costs, or the costs to be borne by a consumer choosing to move to a competitor’s products and/or services: learning a new set of product/service interface actions and rules, changing work practices, out-of-pocket expenses, etc. When substantial switching costs exist, the competitor must not only induce consumers to switch, but also compensate the consumer for borne switching costs. For example, while eBay has faced stiff competition from other auction sites, a key switching cost that works in its favor is that reputations built on eBay are lost. A second type of preemption barrier involves the anticipated effort required to identify and attract new value stream participants and to assimilate these new participants within a value stream’s platforms. For example, Dell’s success in negotiating the participation of other firms in its build-to-order pipeline ecosystem proved to be a dominating preemption barrier. How effective are these barriers to competitive retaliation in the face of digital disruption? With competitors reacting faster and faster and with markets increasingly 100

susceptible to new entrants, about the only things that can be said with confidence are that the length of time any competitive gain can be sustained is growing shorter and that the best defense is to take the offense; that is, take a second competitive action before the competition can react to the initial action. A Recap and Look Ahead This chapter has examined how digitalization has transformed pipeline organizations’ digital strategies and digital strategy formulation processes. However, one critically important topic was not discussed – today’s reality that many, if not most, of the digitization and digitalization capabilities being applied by both pipeline organizations and network organizations in taking competitive moves and in executing business models are externally-sourced, rather than internally-sourced. Explanations of why this is the case and of the strategic implications of this phenomenon are covered in the next chapter.

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Chapter 5. Digital Strategy and the External Sourcing of Capabilities

Pipeline organizations rarely compete solely through their own capabilities. Instead, they leverage the capabilities of suppliers, service providers, intermediaries, strategic partners and consumers. While this has always been the case, the two drivers of digital disruption – ever-accelerating advances with digital technologies and

globalization

–

have

dramatically

enhanced

the

availability,

ease-of-

implementation, reliability and cost-attractiveness of externally-sourced capabilities. As an illustration of what is possible today, consider the publisher of this book: Legerity Digital Press (LDP).

Owned, managed and operated by five individuals

(contributing intangible assets but little else), LDP has no employees and few assets (e.g., an acquired digitalized accounting system, personal productivity tools, etc.), other than the digital books that have been published.

The vast majority of the

resources applied across LDP’s value stream are provided by external parties: the digital platform hosting LDP’s website, the digitalized platform hosting LDP’s B2C storefront, the digitalized platforms hosting payment and banking processes, the digitalized platforms producing hard copies and course packs, the digitalized platforms providing sales channels to university books stores and to libraries, and a provider of advanced accounting and tax services. While the experiences of entrepreneurial startups like LDP are clearly different from those of mid- and large-sized organizations, an ever-increasing portion of the capabilities enabling organizations’ business models have been (or are being) externalized – that is, handled (in full or in part) by other organizations.

The

externalization of a capability, popularly referred to as outsourcing, involves 102

transferring ownership and decision rights regarding a capability, the assets used in executing the capability, and/or the management of the capability from inside an organization’s boundary to outside this boundary. Capabilities are externalized in order to accomplish work activities quicker, more effectively, more efficiently and/or less costly. By making measured decisions about which capabilities to externalize and the governance of these externalized capabilities, significant improvements in organization performance can occur. This chapter describes how external sourcing is brought into digital strategy formulation by covering the following topics: 

Externalizing Organizations’ Capabilities



Tactics for Lessening Clients’ Dependence on Sourcing Providers



External Sourcing and Digital Strategy Formulation



Achieving External Sourcing Agility at Commonwealth Bank of Australia

Externalizing Organizations’ Capabilities Organizations apply a broad array of capabilities in developing, marketing, producing, selling, delivering and supporting the value-units offered to consumers. It is useful to recognize that this broad array of capabilities can be categorized into three capability-sets, each of which focuses on a value discipline: operations excellence, customer intimacy and product leadership.26,27

These capability-sets,

described in Table 5-1, drive distinct operational and managerial processes, benefit from distinct orientations, and have distinct underlying economics. Because of these

M. Treacy and F. Wiersema, “Customer Intimacy and Other Value Disciplines,” Harvard Business Review, January-February 1993, pp. 84-93. 27 J. Hagel, III, Out of the Box, Boston: Harvard Business School Press, 2002. 26

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differences, it can be challenging for any organization to execute all three capabilitysets exceptionally well.

As a result, organizations tend to be organized as three

separate units (each focused on a specific value discipline) that are coordinated so as to operate as a single enterprise.

Invariably, though, these units’ distinctive

incentive systems and control systems bump into and work against one another. Table 5-1 Three Distinct Capability Sets Value Discipline Capability Set Operations Excellence Key Operational & Managerial Processes

Production Purchasing Logistics

Customer Intimacy Product Leadership Value Proposition Development Consumer Development Consumer Retention

Growth

Research and Development Value-Unit Launch New Market Development

Organization Orientation Focus

Quality Cost

Consumer Responsiveness

Adaptation

Underlying Economics

Economies of Scale

Economies of Scope

Economies of Speed

Innovation

Executive leadership teams thus face a complex trade-off.

Should they

unbundle – that is, fully or partially externalize - one or two of these capability-sets so that their enterprise has a singular strategic/operational focus? Or, should they maintain all three units within their organization’s boundaries in order to avoid the challenges that arise in coordinating work across multiple organizations?

If the

decision process of unbundling is handled well and if externalized capabilities are governed well, clear benefits can arise (see Table 5-2).

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Table 5-2 Benefits from the External Sourcing of a Capability Benefits

How Benefits Are Realized  Provider exploits economies-of-scale.  Provider uses leading-edge digital resources in enabling offered capabilities.  Provider embeds leading-edge technical, business and managerial expertise within offered capabilities.

Operational Efficiency & Effectiveness Leverage Provider’s Capital

 Provider owns the digital resources enabling offered capabilities.  Client transfers to the provider ownership of some (or all) of the digital resources previously used to enable the externalized capabilities.

Adaptive & Entrepreneurial Agility

 Client replaces fixed costs with variable costs.  Provider exploits economies-of-scope & economies-of-speed.  Provider uses leading-edge digital resources in enabling offered capabilities.  Provider embeds leading-edge technical, business & managerial expertise within offered capabilities.

Innovation

 Provider exploits economies-of-scale, economies-of-scope & economiesof-speed.  Provider uses leading-edge digital resources in enabling offered capabilities.  Provider embeds leading-edge technical, business & managerial expertise within offered capabilities.

These benefits can be especially attractive when an offshore provider, rather than an onshore provider, is used. An offshore provider is located in a different country than the client, and an onshore provider is located in the same country as the client. Offshore providers can provide appealing rate structures (attributed to low labor rates, tax incentives, etc.), as well as access to scarce skill-sets, and often exhibit exceptional production/delivery capabilities as a result of their exploitation of economies-of-scale, economies-of-scope and economies-of-speed.

Additionally,

organizations that aggressively pursue globalization are often able to leverage their relationships with offshore providers to enrich their understandings of other countries’ business and social cultures. The benefits from externalizing capabilities do not come without risk (see Table 5-3), and these risks only intensify when offshore providers are used. Why do these risks intensify?

Note, in particular, the first two risks listed in Table 5-3.

First, 105

because an off-shore provider’s employees can exhibit linguistic and cultural differences relative to a client’s employees, communication can prove troublesome with seemingly subtle differences in interpretations leading to severe and unexpected problems. Second, over time and all too often, a client externalizing a capability can become overdependent on the provider, as internal expertise regarding the capability is lost (because internal staff is transferred to the provider, assigned other internal roles or let go). As a consequence, the client’s capabilities to govern the provider’s performance and to incorporate the externalized capability within digital strategizing are both reduced. Client-provider misunderstanding and client overdependence on a provider also exacerbate the remaining risks listed in Table 5-3. Of course, many other factors (e.g., technical, contractual, legal, political, etc.) also contribute to these other risks. Table 5-3 Potential Risks Arising from the External Sourcing of Capabilities

Client Risks

How Risks Unfold

Client-Provider  Failures of client & provider managerial/operational staffs to understand Misunderstanding each other’s values, perspectives, objectives, concerns, directions, etc. Overdependence on Provider Inadequate Efficiency & Effectiveness Inability to Leverage Provider’s Capital

 Loss of internal capability expertise and of attention.  Expected cost reductions not fully realized and those that are realized dissipate over time.  Externalized capabilities and the execution of these capabilities are insufficiently enhanced over time.  Provider fails to refresh the digital resources enabling externalized capabilities.  Client allows transferred digital resources to reappear internally.

Inadequate Adaptive Agility

 Provider fails to respond to best-practice adaptations regarding externalized capabilities.  Provider fails to transfer best-practice knowledge regarding externalized capabilities to client.

Inadequate Entrepreneurial Agility

 Provider fails to maintain leading-edge expertise regarding externalized capabilities.  Provider fails to transfer leading-edge expertise regarding externalized capabilities to client.

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Tactics for Lessening Clients’ Dependence on Sourcing Providers A particularly troublesome concern whenever capabilities are externalized is the threat of becoming overdependent on the sourcing provider.

Best practices

aimed at forestalling provider-overdependence include: 

Maintaining internal expertise regarding externalized capabilities.



Enlarging the set of providers with whom capabilities are externalized.



Establishing effective governance of externalized capabilities.

Among these, the maintenance of internal expertise is most important because it’s absence precludes the other two practices. Today, the two tactics most commonly used to enlarge the set of providers are multisourcing and crowdsourcing, and they are described in the remainder of this section. Tactics relating to governance are covered in the next section. Multisourcing Multisourcing refers to contracting with multiple providers rather than a single provider. Initially, this tactic involved a client separating the capabilities to be externalized into relatively independent sets, and then using different providers for each of these capability-sets. remained.

Note, however, that a threat of overdependence

Over time, multisourcing has evolved to become much more

sophisticated, with current best practices advocating:28 

A capability-set to be externalized is modularized, such that each of the modules can be optimized without considering the modules (of this same

These steps are derived from: B.A. Aubert, C. Saunders, C. Wiener, R. Denk and T. Wolfermann, “How Adidas Realized Benefits from a Contrary IT Multisourcing Strategy, MIS Quarterly Executive, September 2016, pp. 175-194. 28

107

capability-set or of other capability-sets) with which it might interact. 

Providers, possessing comparable capabilities, are identified as suitable candidates for handling the capability-set to be externalized.



Multiple providers are then selected to handle a subset of each of these modules, ensuring that considerable overlap occurs in the nature of the modules assigned to the providers.



Provider assessment and reselection procedures are regularly undertaken.

While such practices do introduce increased managerial overhead, the benefits are many: reduced operational and strategic risks, greater likelihood of finding the bestfitting provider for a module (or set of modules), and sustained competition among the providers (e.g., price, quality, responsiveness, reliability, innovativeness, etc.). A further twist on multisourcing involves incorporating a long-tail perspective. Here, the selection of providers to handle the externalized capabilities “… combines a few key partnerships with a dynamically changing and unrestricted number of smaller contracts with other suppliers.” 29 This long-tail aspect thus embraces and fosters a flow of new providers offering new capabilities to drive the client’s adaptive and entrepreneurial agilities. Crowdsourcing Crowdsourcing involves externalizing a capability to a community of individual agents, more popularly referred to as the wisdom of the crowd.

The

fundamental idea of crowdsourcing is that a crowdsourcer proposes to a community of potential contributors the voluntary undertaking of a task that consists of or is enabled by the capability being externalized. Most often, crowdsourcing reflects a

N. Su, N. Levina and J.W. Ross, “The Long Tail Strategy for IT Outsourcing,” Sloan Management Review, Winter 2016, p. 82. 29

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partial, temporary externalization of a capability. Community members contribute to task accomplishment via a collaboration platform. The power of crowdsourcing lies in aggregating and integrating knowledge from diverse, independent contributors.

These individual contributors bring with

them personal knowledge and social information, i.e., information formed through exposure to the contributions of other community members and these members’ expressed confidence in their contributions.

When personal knowledge is weak,

people tend to rely more on social information.

But, overdependence on social

information (which can be systematically-biased if a community’s members share common values, backgrounds and experiences) can lead to overconfidence and groupthink.

For this reason, crowdsourcing tends to produce the highest quality

outcomes when the interacting contributors hold diverse sets of personal perspectives and knowledge. There are two basic types of crowdsourcing: collaboration and tournament. In collaboration-based crowdsourcing, contributors collectively create a single task outcome.

Usually, the community collectively generates ideas, selects the most

promising of these ideas, and refines these selected ideas into the single task outcome.

By contrast, tournament-based crowdsourcing involves community

members (working individually or in teams) submitting finalized, independent task solutions.

The crowdsourcer then selects one of these contributed solutions, or

perhaps a few of the solutions, in exchange for financial or non-financial compensation. Tournament-based and collaboration-based crowdsourcing can be combined, e.g., by first engaging a community to submit individual solutions, and

109

then collectively engaging the community to evaluate the individually-submitted solutions and to refine the best of these into a final task outcome. Table 5-4 defines three common crowdsourcing arenas. Many organizations have applied crowdsourcing to generate innovative ideas. Most often, this arena finds an organization (for example: Dell, Finnair, LEGO, Nestle and Starbucks) engaging a consumer community through social media to generate ideas for enhancing a value proposition or to extend a product line. But other communities can be targeted, as well. For example, Zara, the Spanish clothing retailer, targets its internal community of retail store staff to generate a constant stream of ideas regarding fashion trends ideas gleamed from the staff members observing customer behaviors and talking with customers. Table 5-4 Three Crowdsourcing Arenas Arena Generate Innovative Ideas

Description Engage a community to generate innovative ideas

for improving current value propositions and/or developing new value-units and markets. Engage a scientific/analytic community to (1) solve Solve a Problem a problem or accomplish a task or (2) handle or Accomplish a problems/tasks that otherwise would be assigned to Task internal staff. Engage a broad, diverse community to contribute their personal judgments regarding an issue. Contributors both state their opinions and convey Prediction the strength of the sentiments underlying these Market opinions, and then receive almost instantaneous feedback on how their opinions compare & contrast with others’ opinions.

The second crowdsourcing arena targets a community of skilled-individuals to solve a problem or to handle a recurring task.

Notable examples of the former

objective are the tournaments established by Netflix to produce a next-generation recommendation engine and by NASA to design a laundry system for the 110

International Space Station. Many examples of the later objective exist, especially with regard to software coding and Big Data analytics. Prediction markets, the third crowdsourcing arena, targets broad, diverse communities to predict events or outcomes.

While early uses were directed at

election campaigns and sports contests, business organizations (such as Google, Ford and Best Buy) are realizing considerable value from prediction markets in areas as diverse as forecasting the sales of about-to-be-introduced video games or songs, filtering the ideas about to enter a new product development process, designing and selecting between marketing campaign themes, and selecting projects to be funded. Prediction markets operate in a manner similar to financial stock markets: 

A question is posed to participants (e.g., “Do you wish to buy specific stock?”).



Participants convey their opinions along with the strength of the sentiments underlying these opinions (e.g., “Yes, and here is what I am willing to pay for that stock.”).



Participants receive almost instantaneous feedback on how their opinions compare and contrast with those of other participants (e.g., the current market price for the stock).

Governing the External Sourcing of Capabilities Table 5-5 describes the challenges that are confronted in the design of the governance systems used with externalized capabilities. Two key insights should be gleamed from this table. First, the pragmatic purpose in externalizing a capability is to externalize the work activities (that is, the operational and managerial processes) enabled by the capability.

As work activities are far more tangible than are

capabilities, work activities tend to be the focus of governance systems. Second, these challenges underscore the importance of building and then maintaining internal expertise regarding a to-be-externalized capability – and, accordingly, internal 111

expertise of the work activities enabled by an externalized capability. If a client’s employees do not possess deep understandings of a work activity, low likelihoods exist that these employees would be able to negotiate an effective contract with a provider and to nurture a meaningful trust between themselves and the provider’s employees carrying out the work activity. Table 5-5 Challenges in Governing an Externalized Capability Challenge Understanding of a Work Activity Enabled by Externalized Capabilities

Description

Codifying the Work Activity

Specifying what is to be done, how it is to be done and expected performance outcomes

Monitoring the Work Activity

Observing what is being done, how it is being done and performance outcomes

Devising Metrics of Work Activity Performance

Measuring what is being done, how it is being done and performance outcomes

Developing Trust between Client Employees & Provider Employees

Client employees and provider employees:  understand what is expected of one another  are confident that each will perform their respective work tasks in an ethical, competent & timely manner  are confident that each will adapt to unexpected situations in a manner consistent with relationship objectives.

In devising a governance system for an externalized capability, it is critical to recognize that all external-sourcing engagements focus on one, two or three goals: 

Lowering a capability’s cost structure.



Improving the quality of the capability.



Introducing innovation into the capability.

What varies across arrangements – hence, what varies in the governance systems being applied - is the relative importance (and presence) of these three goals.

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Governance system designs for externalized capabilities can be placed on a tight-governance/loose-governance continuum (see the top half of Figure 5-1). This is important, as the design used affects the goals realized through an engagement: tight-governance works best for cost and quality goals, while loose-governance works best for quality and innovation goals.

Of course, engagements rarely strive to

achieve a cost, quantity or innovation goal. As a result, most engagements tend to involve aspects of both tight-governance and loose-governance (i.e., tightgovernance is applied to some work activities, loose-governance is applied to other work activities, and more-nuanced governance designs are applied to yet other work activities). Figure 5-1 Tight-Governance and Loose-Governance Designs

Tight-Governance Cost-Focus

 Lengthy  Detailed

Loose-Governance Quality-Focus

Contract

Innovation-Focus

 Short  Broad

Administrative Costs Low

High People Costs Low

High

Table 5-6 contrasts the natures of tight-governance and loose-governance. Tight-governance, or compliance monitoring, is characterized by a constant, detailed and deep visibility into how a work activity is being carried out and the extent to which a comprehensive set of negotiated obligations is being met. If both the 113

client and the provider have digitalized their operational business processes, such a visibility is relatively straightforward to implement and is accompanied by associated governance-related costs that are recovered through a lowered risk exposure. With loose-governance, or intent monitoring, the increased discretion given to the provider

inherently

increases

this

risk

exposure

–

an

exposure

managed

(accompanied by associated costs) through the client-provider relationship and by regularly assessing whether or not an engagement continues to prove beneficial for both the client and the provider. As indicated in the bottom half of Figure 5-1, the natures of the costs borne with tight-governance and loose-governance are quite distinct. Table 5-6 Attributes of Tight-Governance and Loose-Governance Designs Tight Governance (Compliance Monitoring) Monitoring Philosophy Decision Making Philosophy

Loose Governance (Intent Monitoring)

Precise execution of wellspecified work activities

Meet agreed-on overall performance outcomes

Defined standards of execution

Joint decision making Client-provider oversight board Client-provider management team  Client engagement manager  Client-provider execution team 

Governance Mechanisms

Metrics Visibility Rights Access Rights

Service Level Agreements (SLAs)



Detailed specifications of Aggregate specifications of the tasks and outcomes to work-related outcomes and risks be monitored and reported Specific transactions and events

Work-related outcomes

Data

Knowledge

External Sourcing and Digital Strategy Formulation External sourcing influences the deliberations of digital strategists in numerous ways. Consider, for example, the following questions: 

What is the portfolio of capabilities being applied, as we gain and sustain 114

advantageous competitive positions? 

Realistically, how good are we at executing and continuously enhancing these capabilities?



Are providers available who are likely to execute and enhance these capabilities better than we can?



Are some of these capabilities strategically more important than others?



Is handling all of these capabilities ourselves the best way to utilize our (limited) internal resources?



What would be the risk exposure of externalizing a specific capability or set of capabilities?



Would we deliver better value to consumers (and to stockholders) if we only hosted internally those capabilities critical to our gaining and sustaining competitive advantages and relied on best-of-class providers to host most (perhaps all) other capabilities?

As stated earlier, such deliberations are increasingly resulting in organizations choosing to externalize many, if not most, of the capabilities enabling business models. As organizations’ digital strategists and leadership teams become comfortable with the idea of externalizing capabilities to arms-length providers (via tightgovernance) and to strategic partners (via loose-governance), strategic opportunities may arise where an organization’s internal capabilities are recognized as being world class and become the basis of a new business model. If a manufacturing organization has developed a world-class inventory management capability, why not take over its suppliers’ or customers’ inventory processes (referred to as vendor-managed inventory) or offer this capability to other manufacturing organizations?

If a

hospitality organization has developed world-class customer support capabilities, why not spin off a subsidiary offering this capability to other companies?

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Digital strategists today find themselves regularly considering whether or not internally-hosted

capabilities

should

be

externalized,

whether

externalized

capabilities should be brought back inside the organization, and whether or not internal, world-class capabilities should be offered to other organizations. More than ever before, organizational boundaries seem to be in an almost perpetual state of flux – a state of flux incessantly driven by the continued advances occurring with digital technologies and by the forces of globalization. Digital Strategy Formulation Figure 5-2 provides an overview of how the external sourcing of capabilities influences digital strategists’ deliberations. The key element introduced in this Figure is an explicit categorization of capabilities within the operant strategic intent: 

Strategic core capabilities – the capabilities that lie at the heart of an organization’s competitive advantage.



Peripheral core capabilities – the capabilities that are necessary for an organization to gain and maintain its competitive positions, but that are not a source of competitive advantage.



Commodity capabilities – the capabilities that are required or are otherwise beneficial for an organization to operate and are readily available from external sources, but do not contribute to competitive positions (aside from their absence).

Strategic core capabilities are seldom considered for external sourcing – and only when a trusted world-class provider exists that is able to outperform the organization now and into the future. Peripheral core capabilities should always be candidates for external sourcing – aside for capabilities for which an organization demonstrates word-class performance. Commodity capabilities should be externally-sourced in the absence of a strong business case for not doing so.

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Figure 5-2 Influence of External Sourcing of Capabilities on Digital Strategizing  External sourcing of capabilities by competitors  External sourcing of capabilities in adjacent markets  Consumers’ beliefs & preferences about the external sourcing Strategic Intent Beliefs regarding capabilities  Strategic core  Peripheral core  Commodity

Business Model Deliberations  Value proposition  Profit model  Core capabilities  Dynamic capabilities

Business Model Enhancement, Replication & Innovation

 Internally-sourced capabilities  Externally-sourced capabilities  New providers  Innovative provider business models

With digital disruption, it is important to recognize that today’s peripheral core capabilities may very well become tomorrow’s strategic core capabilities or tomorrow’s commodity capabilities. (Similar statements could just as well be said about strategic core capabilities or commodity capabilities.) Why do we see, over time, movements in organizations’ core capabilities across these three categories? Four explanations should immediately come to mind: 

Existing markets and business models evolve over time and eventually disappear, while new markets and new business models regularly emerge.



Existing participants regularly leave markets, while new participants regularly appear.



Organization’s internally-hosted capabilities improve and diminish with time.



Existing digital technologies incessantly improve, but eventually get replaced by technological innovations providing lower costs, improved performance and new capabilities.

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Business Model Adaptations Table 5-7 lists the main pathways through which the external sourcing of capabilities contributes to organizations’ business model adaptations. Most of these adaptations are quite straightforward and, hence, are not discussed. However, the adaptations regarding value propositions may benefit from some elaboration. Table 5-7 Business Model Adaptations Associated with External Sourcing Value Propositions

Profit Models

 Exploit provider capabilities to increase current revenue streams, add new revenue  Meet consumer preferences regarding streams and reduce cost structures. external sourcing.  Reduce or reallocate investments in  Modify if and how a capability is sourced to internal assets. become more aware of and more responsive  Renegotiate, replace or eliminate to ecosystem events & trends. unprofitable or less-beneficial externalsourcing engagements.

Core Capabilities

Dynamic Capabilities

 Reassign capabilities into the strategic  Externalize a capability. core, peripheral core and commodity  Re-internalize an externalized capability. categories.  Enhance a capability or add a new capability  Enhance environment scanning aimed at via external-sourcing. identifying and nurturing new providers.  Harden or modularize platforms via the  Modify the composition of the digitalexternal-sourcing of enhanced or new strategists group (including strategic capabilities. partners’ digital strategists).

First, consumers are heard to voice a bias against the external sourcing of capabilities – perhaps most commonly observed with customer support processes, but extending as well to consumers’ preferences regarding external sourcing in general. As a consequence, insourcing a previously-externalized capability may serve as an effective competitive move – especially when an organization has begun to embrace the customer intimacy value discipline and/or if most competitors have externalized the capability. Second, an organization’s proximity to innovative upstream and downstream ecosystems is critical for the organization to demonstrate agility in modifying value 118

propositions.

Employees directly in touch - physically and, most importantly,

culturally - with consumers and with ecosystem participants are simply far better able to identify, incorporate and act upon significant events and trends.

As a

consequence, it is not uncommon today to observe organizations: transferring to onshore providers those capabilities that were previously externalized to offshore providers, and deciding to internally host capabilities that were previously externalized. Achieving External-Sourcing Agility at Commonwealth Bank of Australia30 The strategic advantages of demonstrating agility with regard to the external sourcing of capabilities – that is, easily shifting capabilities from being internally sourced to being externally sourced (or vice versa), and shifting the handling of a capability from one provider to another provider – should be obvious. Organizations demonstrating and maintaining agility significantly enhance the likelihoods of their business

models

maintaining

alignment

with

today’s

dynamic

competitive

environments. But, is agility with external sourcing feasible and cost-effective? The experience of the Commonwealth Bank of Australia (CBA) indicates that it is both feasible and cost-effective. CBA is a large, multinational bank headquartered in Sydney, Australia. It has built a strong reputation as a leading worldwide commercial user of digital technologies (in regard to both spending and innovation).

The banking sector is

especially challenging for digitalization, given the importance of consumer trust – a

This section has been adapted from: D. Schlagwein, A. Thorogood and L.P. Willcocks, “How Commonwealth Bank of Australia Gained Benefits Using a Standards-Based, MultiProvider Cloud Model,” MIS Quarterly Executive, December 2014, pp. 209-222. 30

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trust based largely in consumer perceptions regarding the security, reliability and availability of digitalized banking services. CBA has taken three different approaches to external sourcing over the past twenty years: 

1996: CBA externally sourced much of its digitization and digitalization to EDS (now part of Hewlett-Packard). This single-provider, ten-year contract emphasized fixed fees, guaranteed transaction volumes and lowered costs. Having reduced its internal digitalization-related staffing, CBA’s executive leadership in the early 2000s realized that the bank had lost much of the internal capabilities necessary to launch digitally-enabled competitive actions.



2006: CBA transitioned to a multisourcing approach to the external sourcing of capabilities. Specifically, the bank launched initiatives to rebuild internal digitalization capabilities and to negotiate/manage individual sourcing contracts with a portfolio of external providers. By the end of the 2000s, CBA had rebuilt its internal digitalization capabilities. However, a new concern had arisen: accelerating digitalization costs.



2010: CBA initiated a multi-provider, cloud-based approach to the external sourcing of capabilities. Cloud computing promised a cost-effective, pay-asyou-go approach to external sourcing and a means to launch competitive actions quicker and less-expensively. By 2016, this new approach to external sourcing had resulted in significant digitalization-related cost reductions and significant improvements to the bank’s adaptive and entrepreneurial agilities.

What exactly is CBA’s multi-provider, cloud-based approach to external sourcing? To answer this question, a very brief introduction to cloud computing is needed. Cloud computing involves provisioning a pool of digital assets and digitallyenabled services such that these services can, on demand, be accessed and applied by clients via the Internet.

Cloud computing solutions provide individuals and

organizations with suites of capabilities in either private or public clouds, where these clouds may be located close to or very distant from the client.

The economics of

cloud computing are based on the sharing of a pool of resources across many uses and many users, such that significant economies of scale and scope are realized. 120

CBA’s multi-provider, cloud-based model has three layers (see Figure 5-3). The top layer consists of the business platforms that execute CBA’s operational and managerial processes. The bottom layer includes internal (designed and operated by CBA’s technology group), private external and public clouds – all of which comply with CBA’s cloud standards. CBA collaborated with several cloud providers and other strategic partners to develop and mandate these cloud standards. The middle layer, which consists of a cloud management system, matches the digitalized applications hosted in the top-layer business platforms to the bottom-layer digital platforms (within which data processing and storage actually occurs). The primary purpose of the cloud management system is to dynamically determine which provider’s cloud should execute an application and to assign this application to that cloud. This cloud management system is located inside CBA’s firewall, and CBA manages and controls the system. Actual computing could take place on either side of the firewall according to the cloud management system’s on-demand allocations. Figure 5-3 CBA’s Multi-Provider, Cloud-Based External Sourcing Model

Business Platforms

Cloud Management System

Internal Cloud

External Private Cloud

External Public Cloud

External Public Cloud

External Public Cloud

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The cloud management system executes

operational and

managerial

processes on-the-go, depending on current cloud workloads, the prices and service level agreements negotiated with providers, and general requirements for security, reliability and availability. In addition, the structure shown in Figure 5-3 makes it relatively easy, as long as architectural standards are met, to enhance business platforms, to replace business platforms or to add new business platforms. Finally, this structure is not limited by the number of connected cloud-providers, and it allows for the rapid connection of newly-contracted providers and the rapid disconnection of terminated providers. A Recap and Look Ahead Organizations implementing competitively-successful business models must be able to quickly and competently apply numerous digitized and digitalized capabilities, many of which are quite sophisticated and some of which have only recently emerged. It would be simply impossible for any organization to accomplish this on their own today.

This chapter has explained why and how organizations externally source

many, if not most, of the capabilities being applied, and then described how the external sourcing of capabilities is factored into organizations’ processes for digital strategy formulation. While the external sourcing of capabilities is important for both pipeline organizations and network organizations, it is especially critical for network organizations given these organizations’ intense reliance on digital platforms and business platforms in the launch and evolution of their business models. The next chapter describes the nature of business models within network ecosystems.

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Chapter 6. Digitalized Business Models for Network Ecosystems

Today, when you use your smartphone or tablet to post content on Facebook statuses, to tweet, exchange photos, or search for information on the Internet, you expect these types of Internet-based services to be provided mostly free-of-charge. In economic terms, this amounts to a vast consumer surplus being provided by organizations offering such services. Why do organizations (e.g., Facebook, Twitter, WhatsApp, Google, etc.) offer these free services? The not-so-subtle answer is quite straightforward – to generate revenue streams (via advertising or access fees) by enabling other organizations to touch an expanding network of consumers or to gain access to information about these consumers. But, how does this occur?

Most often, it occurs through the creation of a

network (market-focused) ecosystem, with the core transaction of the market being the free service: a Facebook post, a Twitter tweet, a WhatsApp photo-share, or a Google Internet search.

The core transaction of a network ecosystem is the

primary market exchange activity driving both producers and consumers to an ecosystem’s market platform. The market platform of a network ecosystem is the organized collection of digital and business platforms that hosts the content and functionalities that establish, operate and govern the ecosystem’s market. In order to better grasp the nature of a network ecosystem, let’s take a closer look at Google and Facebook. Also, for the ease of understanding, we will refer to the networks being brought together within a network ecosystem as communities. The core transaction enabled by Google is a consumer’s search for specific content (some unit of information) believed to exist on one or more producer websites 123

(see Figure 6-1).

Note especially the third community involved with Google’s

ecosystem: advertisers. Having developed state-of-the-art search algorithms and an innovative auction scheme for selling advertising associated with specified search outcomes, Google has built a business model that profitably monetizes Internet search by attracting large customer and advertiser communities.

Interestingly,

considerable overlap does exist across the three communities interacting through Google’s search platform: website producers and advertisers do Internet searches (that is, act as consumers), website producers do advertise, and advertisers do place content on websites. Figure 6-1 Google’s Network Ecosystem

Consumers Seeking Information

Advertisers Google’s Market Platform • Access to network of potential buyers • Measurable ROI on ads • Precise campaign control: pay for clicks

• Relevant, useful information • Ease of use • Access from anywhere

Producers of Websites

• Increased traffic • Revenue opportunities • Access to network of advertisers

The core transaction enabled by Facebook is a person’s posting of content (accompanied by Facebook immediately notifying the consumer’s friends of the posting). As depicted in Figure 6-2, the person posting content is a member of a producer community and the friends wishing to see the posted content are members 124

of a consumer community. Somewhat unique to social media sites, these consumer and producer communities essentially overlap their memberships (aside from pure lurkers within the consumer community).

Note also that Facebook’s ecosystem

involves two additional communities: advertisers and Facebook App producers. Facebook generates revenue streams from these advertisers and App producers. Figure 6-2 Facebook’s Network Ecosystem

• Access to networks of consumers & producers • Revenue opportunities • Access to network of advertisers

Producers of Facebook Apps

Advertisers

Facebook’s Market Platform

• Global audience of potential buyers • Measurable ROI on ads • Precise campaign control: pay for clicks

Consumers Seeking Content

• Relevant, useful content • Ease of use • Access from anywhere

Producers of Content

• Increased traffic • Revenue opportunities • Access to network of advertisers

This chapter introduces intuitive ways of thinking about network ecosystems and about the digital and business platforms used to orchestrate the market spaces established by network ecosystems. The following topics are covered: 

Why Network Ecosystems Exist



Crowd-Based Capitalism



Digitalizing Network Ecosystems



Blended Organizations

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Why Network Ecosystems Exist In explaining the economic concepts that underlie network ecosystems, we use the example of a simplified hypothetical social media ecosystem (see Figure 6-3). Here, community members take on the roles of producers and consumers in order to share content. By sharing content – and, hence, gaining exposure to each other’s likes, dislikes, experiences and perspectives - members enrich their relationships with each other.

What is the value proposition that drives a person to join,

participate, and remain in a social media ecosystem? It is the promise of moreintensively sharing content with individuals with whom a personal relationship already exists or of sharing content with individuals with whom no (or, at best, a casual) personal relationship currently exists, but with whom a richer personal relationship is desired. Figure 6-3 Simplified Social Media Ecosystem

Social Media Community Producers of Content

Consumers Seeking Content

Social Media Platform

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This social media ecosystem value proposition is driven by what economists refer to as network effects. Stated simply, as the social community grows linearly, the number of possible relationships amongst the community’s members grows exponentially: 1 member - 0 possible relationships, 2 members – 1 relationship, 4 members – 6 possible relationships, 12 members – 66 possible relationships, 100 members – 4,950 possible relationships, and so on. Bigger networks, as a general rule, are more valuable to participants; thus, network effects give network ecosystems with the largest participant communities an advantage that is hard for competitors to overcome. We explore network effects further, starting with twosided markets, moving on to multi-sided markets, and concluding with a discussion of winner-take-all markets - the competitive endgame of a market-focused network ecosystem. Network Effects Network effects, or what economists term a network externality, refer to situations where the worth of or demand for a value-unit grows as an exponential function of the number of current consumers of a value-unit and/or the number of complements available to these consumers. A complement increases the perceived worth of a value-unit. A good example of a complement would be the apps available for a particular social media ecosystem, e.g., apps that make it easier to manipulate and share content across the ecosystem. Would you be more inclined to join a social media ecosystem that had more or fewer of your current friends as participants? And, is this more likely for larger or smaller social media ecosystems? Now, given two social media ecosystems comparable regarding the likelihood of you being able to share content with your friends, would you prefer the ecosystem with more or 127

fewer valued complements (e.g., an image manipulation app)?

And, would app

producers be more inclined to create apps for larger or smaller social media ecosystems? This is the power of network effects! How can firms capture the opportunities available through positive network effects?

Positive network externalities occur only when a customer network is

satisfied with – better yet, enthused about – the value-unit being offered. Much of Apple’s surge in product success (iPod, iPhone, iPad, iTunes, iMusic, etc.) is a direct result of positive word-of-mouth chatter. In contrast, negative customer experiences and perceptions can be devastating. The competition between HD DVD and Blu-ray as the standard for DVD players provides an example of network externalities in action. Consider this quote from Matthew Smith, a former SVP of merchandising for Blockbuster:31 “The consumers are sending us a message. I can’t ignore what I’m seeing. Blockbuster has been renting both Blu-ray and HD DVD titles in 250 stores since late last year and found that consumers were choosing Blu-ray titles more than 70 percent of the time.” Relatively quickly, word-of-mouth and consumer purchase decisions led to a positive network effect for Blu-ray titles, subsequent growth in the number of Blu-ray titles offered for sale or rent relative to the number of HD titles, and Blu-ray ultimately winning the DVD standards war. Because of the power of network effects, it is critical for network ecosystems to exploit the influence of word-of-mouth and enlist their communities in growing both community membership and member participation within a community.

R. Harris, “Blu-ray vs. HD DVD: Game Over,” http://blogs.zdnet.com/storage/?p=149. 31

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Another tactic for capturing network effects with network ecosystems is to carefully define the architectural standards enabling connectivity and interoperability and promote these standards such that the standards become dominant in the network ecosystem market space. Winning standards wars is critical as this increases the number and variety of complements available to participants.

A primary factor

behind Microsoft’s dominance in PC operating systems was the wide variety of software applications compatible with the Windows operating system. This reinforces the dominance of Windows in the market for PC operating systems. Firms become successful in standards wars either by leveraging their brand and existing market presence (e.g., a Microsoft, an IBM, an Apple, a Google, etc.) or by forming alliances with other firms and collectively engaging in persuasive tactics to influence an industry-wide movement toward a favored standard (e.g., Bluetooth, GSM for mobility services, Android for smart phones, etc.). Two-Sided Markets A key notion for understanding the nature of network ecosystems involves the economics of two-sided markets.32

With a two-sided market, the ecosystem

owner/builder – the network orchestrator – brings together two distinct communities to engage in value-unit exchanges. Most typically, this is accomplished by growing one side of the market as a means of attracting participants to the other side of the market. The two sides of the network ecosystem are perhaps best thought of as a subsidy-side and a money-side, with the ecosystem’s market platform providing

T. Eisenmann, G. Parker and M. Van Alstyne, “Strategies for Two-Sided Markets,” Harvard Business Review, October 2006, pp. 92-101. 32

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the rules, functionalities and resources to attract participants and to facilitate valueunit exchanges.

As a general rule, the subsidy-side is provided incentives to

participate in a network ecosystem as the primary role of the subsidy-side is to attract the money-side, from which revenues are generated. The basic idea, thus, is to grow the subsidized community to the point that its size becomes sufficient to attractive money-side participants willing to pay a fee to gain access to the subsidy-side participants. As an example of a two-sided market, consider Figure 6-4, which depicts a generic job-recruiting network ecosystem, e.g., CareerBuilder, Monster, Job.com, etc. The subsidy-side is the community of individuals looking for a job. By heavily subsidizing (free?) participation and by offering useful rules (e.g., privacy), functionalities (e.g., resume-builder) and resources (e.g., career advice content), a large pool of job candidates is built. If this pool of job applicants is large and of high quality (e.g., broad ranges of skills and experiences), a high likelihood exists that a sizable pool of recruiters will be attracted despite the participation fees being charged to these recruiters (typically, a recruiter might be charged a modest fee to post a job opportunity, a slightly larger fee for each match that occurs, and a much larger fee if and when an applicant is offered a position).

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Figure 6-4 Generic Job Recruiting Network Ecosystem

Recruiters

Applicants

(Producers of Jobs)

(Consumers of Jobs)

Market Platform

Rules

Functionalities

Resources

Another, quite different, example of a two-sided market involves Adobe and its Adobe Reader and Adobe Acrobat software (see Figure 6-5). Before Adobe Reader and Acrobat were released, the established standard for sharing and printing documents was a tool called PostScript. In order to make inroads into the lucrative document creation software market, Adobe made its document reader software freely available (subsidizing the consumers of digital documents) and encouraged adopters to share information about Adobe Reader and how to obtain it. With positive wordof-mouth by a large number of Adobe Reader adopters, Adobe Reader became the de facto standard for document reading and sharing. Once Adobe Reader became the dominant document reader for viewing any type of document, Adobe was able to sell its document-creation software, Acrobat, to all types of document creators: publishers, law firms, authors, etc. While Adobe continues to give Adobe Reader

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away for free, it generates sizeable revenues through its Acrobat software (now available only by lease, a more-profitable pricing tactic). Figure 6-5 Adobe’s Two-Sided Market Business Strategy

Producers of Digital Documents

Consumers of Digital Documents

Market Platform Software Products to Download Payment Systems

User Authentication & Account Management Customer Support & User Manuals

What is important about Adobe’s strategy?

Adobe could have enjoyed the

benefits of network effects by only offering Adobe Reader - by standardizing their use around it, consumers of digital documents would be able to easily exchange documents and read them on any type of device.

However, would this positive

network effect benefit Adobe to the same extent it benefited Adobe’s customers? In other words, would Adobe have been able to eventually sell Adobe Reader at a price sufficient to generate a lucrative profit? What price could it charge without hurting its ability to build a critical mass of document reader users? Adobe recognized that rather severe limits existed regarding what people would be willing to pay for a document reader.

But, Adobe also recognized that it could generate substantial

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revenue from document-creation software given that it could achieve a large, installed base of Adobe Reader users. Figure 6-6 provides a more nuanced depiction of the logic underlying a twosided market. Note that two types of positive network effects are in play. The first is called the same-side effect and refers to the possibility of network effects with each side of the market. In the case of Adobe, as more people adopt Adobe Reader for viewing documents, each is presented with more opportunities to easily share documents. This represents a positive, same-side network effect for the adopters of Acrobat Reader. Potential same-side network effects exist, as well, for document producers. As more producers adopt Adobe Acrobat for document creation, more opportunities arise for these producers to exchange content in order to create bundled offerings. Figure 6-6 Same-Side and Cross-Side Network Effects

Side #2

Side #1

Same-side effect Market Platform

Cross-side effect

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The second type of positive network effect is called a cross-side effect. This refers to the potential value that one side derives when there are more participants on the other side. Again, using the Adobe example, adopters of Adobe Reader benefit as more producers adopt the Adobe Acrobat document creation software (because of the increase in the number of compatible digital documents), and document producers benefit with an increase in the number of consumers reading digital documents through the use of Acrobat Reader (a larger consumer market for produced digital documents). So far, our discussion has been based on the assumption that same-side and cross-side network effects are always positive. This is not the case, as these network effects could be negative.

Refer back to the job recruiting network ecosystem

portrayed earlier as Figure 6-4.

Are the same-side network effects positive or

negative? Does a growing pool of job applicants benefit each applicant participating in the ecosystem? Does a growing list of recruiters benefit each recruiter participating in the ecosystem? Possibly not, as this may translate into greater competition among applicants for the best jobs, as well as greater competition among recruiters for the best candidates. Even though each side benefits from positive, cross-side network effects, the potential for negative, same-side network effects could limit the number of job seekers or job providers willing to participate in the ecosystem.33

The way job recruiting network systems typically deal with negative, cross-side network effects is to segment the pools of available jobs and applicants into ‘sub-markets’ that become more-level playing fields for both recruiters and applicants. 33

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Multi-Sided Markets Increasingly, today’s network ecosystems are designed as multi-sided markets rather than as two-sided markets. A multi-sided market involves more than two actively participating communities. In this chapter’s introduction, we described a three-sided market (the Google search network ecosystem) and a four-sided market (the Facebook social media network ecosystem). With multi-sided markets, each added community presents an opportunity to generate additional revenue streams. Facebook, for example, receives revenue from advertisers and from app producers.

But, this potential for increased revenue is

accompanied by three management challenges: 

Creating and then evolving attractive value propositions for each participating community.



Identifying and optimizing positive same-side/cross-side network effects.



Identifying and minimizing negative same-side/cross-side network effects.

As the number of communities participating in a multi-side network increases, the complexity of these management challenges tends to increase in a nonlinear fashion. Winner-Take-All Markets Increasingly, the payoff gap between being the best competitor in a market and the second-best is widening into a canyon. This applies to labor markets (e.g., professional athletes), to technology markets (e.g., technology producers), and especially to network ecosystems.

In explaining the nature of winner-take-all

markets, we begin with the most straightforward context – that of a digital product/service.

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As positive network effects drive more consumers to adopt a product or service, the product/service can gain a critical mass of adopters and become dominant in its market space.

This same phenomenon occurs with network

ecosystems. A critical mass of network ecosystem participants is achieved when the momentum produced by an ecosystem’s positive network effects is unlikely to be reversed by the entry into the market space of an appealing new network ecosystem, regardless of how appealing this new ecosystem’s value-units might be. Think of the market dominance held by Microsoft Windows and Office, by Google’s Android and Gmail, and by Blu-ray DVD players and movies.

In each of these cases, the

respective markets are said to have tipped over with the winner crowding out rival products or services. A winner-take-all market, thus, refers to a market where the potential exists that a critical mass of consumers will adopt one producer’s products/services. Nintendo’s entry into the home video gaming market nicely demonstrates how competition unfolds in winner-take-all markets. In 1985, Atari was the dominant firm in the video game market. By Christmas 1986, the Nintendo Entertainment System (NES) had emerged as a very popular product, creating positive network effects with both customers and, importantly, game developers, in turn attracting even more customers. At some point, the market tipped over to Nintendo as the dominant competitor. Once this occurred, game developers were willing to produce their software exclusively for Nintendo for a two-year period – indicating the significant rewards winners can obtain in winner-take-all markets.

Microsoft’s

business strategies with its operating systems and its Office software suite reflect similar competitive dynamics. 136

Network ecosystems are particularly susceptible to winner-take-all markets. Three factors tend to characterize winner-take-all network ecosystems: 

Strong producer economies of scale.



Strong positive cross-side network effects.



High consumer switching costs.

The latter factor is especially important. When participating in a competitor network ecosystem is perceived as being costly (i.e., a non-trivial investment is required to participate in a network ecosystem and this investment is then lost in moving to a different ecosystem), consumers will be reluctant to either participate in multiple network ecosystems or to switch ecosystems. Importantly, not all market spaces are susceptible to winner-take-all market dynamics.

Consider the market space for daily deals, e.g., Groupon and

LivingSocial.34 Many early investors believed that strong cross-side network effects would produce high stock valuations for Groupon and for LivingSocial. However, as consumers participating in Groupon and in LivingSocial experienced very low switching costs, little allegiance was shown to any one market platform with consumers instead skipping through multiple platforms looking for the most attractive deals. As one might expect, the high valuations have yet to materialize. Generally, a market space susceptible to winner-take-all dynamics is most likely to be seen as a winner-take-all network ecosystem when: 

Participants experience significant, positive network effects.

A. Haigu, “Strategic Decisions for Multi-Sided Platforms,” Sloan Management Review, Winter 2014, pp. 71-80. 34

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

Participants are reluctant to move to a competing ecosystem.



One of the network ecosystems begins to attract a majority of the new participants entering the market space.



This same ecosystem attracts an accelerating flow of participants from competing ecosystems.

Competition in early-stage winner-take-all network ecosystem market spaces can be fierce. More profitable competitors, because they are more profitable, are able to invest more in R&D and to provide greater incentives to participants - enabling their participating communities to grow even faster. This intense competition often results in winner-take-all market spaces being dominated by just a few firms (two or three, at most). Crowd-Based Capitalism The past decade has witnessed a reemergence of bartering, the earliest type of market-focused ecosystem, in the form of crowd-based capitalism – that is, a two-sided market that brings together two crowds, or communities, of individuals: one community possessing an under-used asset or skill (the value-unit) and the other possessing a short-term need for such an asset or skill. This new bartering ecosystem differs from the original in two important ways: 

The medium for the short-term sharing of the value-unit is money. In other words, the person that owns the shared value-unit gets paid by the person being granted short-term use of the value-unit.



The market is enabled through a digitalized market platform built, managed and owned by a third-party, the network orchestrator.

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This form of market-focused ecosystem is the basis for what is popularly referred to as to as the sharing economy.35 Essentially, digital technologies (e.g., the Internet, interconnected smart devices, social media, payment systems, trust systems, etc.) are extending peoples’ options for obtaining goods and services beyond family, friends, neighborhood stores and national/global retailers toward crowds of entrepreneurs. Table 6-1 lists some of the crowd-based network ecosystems that have emerged over the last decade. As you look over this listing, notice the attributes of value-units likely to be shared via crowd-based capitalism: low-use and high-value. Low-use implies unused capacity (of an asset) or idle time (of a skill-provider); highvalue infers that the value-created – the consumer payment subsequently appropriated and shared by a producer (an asset-owner or skill-provider) and a network orchestrator – will exceed the costs associated with an exchange.

A. Sundararajan, The Sharing Economy: The End of Employment and the Rise of Crowd-Based Capitalism, MIT Press, Cambridge, MA, 2016. 35

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Table 6-1 Examples of Crowd-Based Network Ecosystems Crowd-Based Network Ecosystem Educational Services

Freelance Work Fundraising

Handyman Chores High-End Fashion

Lodging Personal Services Philanthropy Transportation

Value-Unit

Examples

SkillShare,TradeSchool, Udemy Amazon Mechanical Turk, Idle Expertise Capacity InnoCentive, TopCoder, Upwork AngelList, FundiingCircle, Idle Capital Kickstarter Idle Labor Capacity Handy, TaskRabbit, TimesFree Designer24, Rendevoux, Rent My Unused Clothes Wardrobe, Rent the Runway, StyleLand Unused Housing Capacity Airbnb, CouchSurfing Lux, Postmate, Shyp, Washio, Idle Labor Capacity Wag Idle Capital DonorsChoose, Kiva Unused Automobile BlaBlaCar, Getaround, Lyft, Turo, Capacity Uber, Zipcar Idle Skill Capacity

Digitalizing Network Ecosystems Network ecosystems existed prior to the eras of digital disruption.

For

example, three pervasive pre-digital network ecosystems were those involving (as network orchestrators) real estate brokerages, independent insurance agencies and travel agencies. In these network ecosystems, the network orchestrator (via the work processes shown in Figure 6-7): 

Built up a portfolio of offerings from a producer community.



Attracted a consumer community.



Enriched producers’ offering creation capabilities.



Enriched consumer demand.



Matched the needs of individual consumers with the producer’s offerings.



Facilitated both exchange transactions and exchange fulfillment.



Worked to retain the members of the producer and consumer communities.

With digitalized network ecosystems, the vast majority of work processes are carried out through a market platform (i.e., a collection of digital platforms and business 140

platforms). The digitization and digitalization reflective of the three eras of digital disruption (see Table 6-2) have produced two types of effects on network ecosystems.

First, the pre-digital network ecosystems have either radically

transformed themselves through both digitalization and specialization or have exited their markets.

Second, scores of new network ecosystems have emerged and

continue to emerge (see Table 6-3). Figure 6-7 A Network Orchestrator’s Managerial and Operational Processes Business/Digital Strategizing; Administrative Services

Support Processes

Financial Services; Accounting Services

Digital Technology Services & Management Human Resource Recruitment & Development; Benefits Management R&D; New Services Development; New Services Rollout

Primary Processes

Indirect Materials & Supplies Procurement Growing a Producer Community

Growing a Consumer Community

Facilitating Producer Value-Unit Creation Stimulating Consumer Demand

Matching Consumer Demand With Producer Supply

Transaction Execution Efficiency & Safety

Exchange Fulfillment Execution & Safety

Retaining Producer Community Retaining Consumer Community

141

Table 6-2 Evolution of Network Ecosystems Era

1

2

3

Value-Units

Digitization & Digitalization

Digital complements

 Data/document standards  Point-to-point connectivity  Intra- and interorganizational (managerial and operational) process efficiencies

Exchange Currency

Trust Systems

 Banking system  Credit/debit card systems

 Government & 3rd- party institutions  Contracts  Brand  Social capital

Digital valueunits

 Internet  One-to-many connectivity  Data, process, analytic and collaboration platforms  Social media  Omni-channel producerconsumer interaction

 Digitalized payment systems

 3rd-party digital trust seals  Consumer monitoring (product & producer reviews)

Social complements

 Many-to-many connectivity  Smart devices  Big Data platforms  Big Data analytic platforms  Social messaging platforms

 Reputation  Social capital  Bitcoins

 Community monitoring  Peer-regulation  Self-regulation

Table 6-3 Examples of Network Ecosystems Era

Variation

Examples

Services Platform

Visa, MasterCard

Producing Organizations

Banks

Consumers

Digital Architecture

Microsoft’s PC Operating System

Application Producers

PC Producers

Consumers

B2B Horizontal Marketplace

Alibaba.com, Thomasnet.com

Producing Organizations

Advertisers

Consuming Organizations

B2B Vertical Marketplace

e-Steel, Farms.com Amazon Marketplace

Producing Organizations

Advertisers

Consuming Organizations

Producing Organizations

Advertisers

Consumers

eBay, Craigslist

Producers

Advertisers

Consumers

Search Platform

Google

Content Producers

Advertisers

Content Consumers

Social Media Platform

Twitter

Content Producers

Advertisers

Content Consumers

Crowd-Based Capitalism

Airbnb, Uber

Asset/Skill Owner

Advertisers

Asset/Skill User

1

2

B2C e-Commerce C2C e-Commerce

3

Community 1 Community 2 Community 3

142

Era 1 Two types of network ecosystems emerged during Era 1. The first of these applied proprietary, point-to-point connectivity to create new markets based on digitalized services.

Perhaps the most familiar example is that of credit card

providers, such as Visa and MasterCard.

By establishing a digitalized (in part)

services platform, merchants were able to offer a convenient, safe payment channel to consumers and banks gained a new revenue stream. The second type of network ecosystem that emerged involved proprietary architectures for digital products and these product’s complements. By promoting and licensing a product architecture that tips over a market, the architecture’s creator is able to sustain high-margin sales for a lengthy period of time. Perhaps the most familiar example of this is that of personal computer (PC) operating systems, such as Microsoft OS (and then Windows). The Intel PC operating system market tipped over to Microsoft OS because the PC application software community gave priority to developing products to run on OS (and then on Windows) – increasing the likelihoods that software producers would gain large revenue streams and that consumers purchasing PCs would be able to run needed software. Era 2 The availability of one-to-many connectivity enabled by the Internet triggered a rapid growth in network ecosystems.

Four distinct types of e-commerce

ecosystems emerged: B2B horizontal (producers offering a broad range of valueunits to any type of consumer-business) marketplaces, B2B vertical (producers offering value-units to consumer-businesses in a single industry) marketplaces, B2C marketplaces, and C2C marketplaces. 143

B2B marketplaces generally operate in the upstream portions of industry value streams. Connecting (raw material and component) suppliers to producers, these intermediaries aim to disintermediate established supplier-producer relationships with the promise of a more efficient market. The value-propositions of these B2B marketplaces vary considerably, as reflected in the four levels of functionality that can be established between producers and consumers: information exchange, valueunit exchange/fulfillment transaction execution, logistical flow coordination, and collaboration enablement. B2C and C2C marketplaces generally operate in the downstream portions of industry value chains.

Connecting finished goods producers to consumers, these

intermediaries aim to disintermediate established retailer-consumer relationships, again with the promise of a more efficient market. Notice in Table 6-3 (shown earlier) that the example given for an Era 2 B2C network ecosystem is Amazon Marketplace rather than Amazon, given Amazon Marketplace’s objective of bringing together a broad community of small producers to interact with Amazon’s consumer community. Two examples of C2C marketplaces, eBay and Craigslist, are used to illustrate the variety that exists. For example, eBay utilizes an auction pricing mechanism and offers the parties of value-unit exchanges a range of transactional and fulfillment services, while Craigslist utilizes fixed prices and offers little in the way of transactional and fulfillment services. Era 3 The digital technologies associated with the third era of digital disruption – most notably many-to-many connectivity, smart devices, social messaging and peer regulation – triggered a fresh, explosive wave of network ecosystems focused on 144

enabling and exploiting individuals’ desires to maintain anytime, anywhere connections with the people, institutions and opportunities that are most important to them.

As listed earlier in Table 6-3, the dominant types of Era 3 network

ecosystems involve digital services (e.g., search, photo sharing, music sharing, etc.), social media, and crowd-based capitalism. As many of these network ecosystems involve participants and activities outside of the purview of established markets and institutions, new forms of community-based and peer-based trust systems have emerged. For example, there are limited regulations at present to assure consumers of the accuracy of host-provided Airbnb lodging descriptions. In response, Airbnb has implemented two trust mechanisms: the capturing and reporting of consumers’ lodging reviews, and host identity verification systems that combine the digitized social capital of social media with governmental ID infrastructures.

In addition,

Airbnb proactively involves hosts and consumers in developing and evolving standards and expectations guidelines that must be agreed-to by hosts and consumers. Blended Organizations Today’s most successful organizations are increasingly exhibiting the qualities of both pipeline ecosystems and network ecosystems, and in the process becoming a blended organization. This primarily occurs via one of two approaches: 

An organization operates multiple, largely independent business models, some of which are executed as a pipeline organization and others as a network organization.



A pipeline organization incorporates a private or semi-private networkecosystem as a means of enhancing efficiency, effectiveness or both.

Each of these approaches is briefly described. 145

The organization that best illustrates the first approach of operating both pipeline ecosystem and network ecosystem business models is Amazon. Amazon’s initial business model was that of a pipeline ecosystem retailer: interacting physically with suppliers to stock product inventories, then interacting digitally with customers to sell these products, and then interacting physically and digitally with third-party package delivery providers in fulfilling customers’ purchases from Amazon’s brickand-mortar distribution centers. Over time, Amazon has expanded its portfolio of business models to include operating as: 

A pipeline ecosystem retailer that stocks, sells and delivers digital products and smart devices.



A pipeline ecosystem producer of digital technology services for businesses and for individuals.



A network ecosystem orchestrator of media streaming services.



A network ecosystem orchestrator of B2B and B2C marketplaces.

While Amazon’s various business models are targeted at distinct markets, they all make extensive use of Amazon’s world-class capabilities to design, build, operate and evolve digital platforms and business platforms. The second approach to becoming a blended organization involves a focus on upstream, internal and/or downstream processes. With regard to upstream processes, for many producers (e.g., automobiles, durable appliances, electronic products, etc.) a few of the raw materials used in procured components represent a significant percentage of production costs. Part A of Figure 6-8 portrays a traditional upstream value stream for a pipeline manufacturing organization. Note that value stream participants engage with two largely-independent markets: Market 1 involves raw material suppliers and 146

component suppliers, and Market 2 involves these component suppliers and the producers. Because of the potential for supply/demand imbalances and information asymmetries, component suppliers tend to be disadvantaged in Market 1, passing on market inefficiencies to the manufacturer in the form of higher prices and logistical delays in Market 2. Part B of Figure 6-8 introduces the notion of a supply hub as a means of overcoming these potential market inefficiencies in this upstream portion of the traditional pipeline value stream.36 Here, the manufacturer creates a pseudomarket (Market 3) within the established market for raw materials. After aggregating raw material requirements and production plans across all component suppliers, a producer is able to apply a comprehensive understanding of component supplier demand (volumes and timings) in negotiating prices with raw material suppliers on behalf of the component suppliers.

A. Agrawal, A. De Meyer and L.N. Van Wassenhove, “Managing Value in Supply Chains: Case Studies on the Sourcing Hub Concept,” California Management Review, Winter 2014, pp. 23-54. 36

147

Figure 6-8 Introducing a Supply Hub into a Pipeline Ecosystem Value Stream A. Traditional Value Stream Raw Material Suppliers

1

Component Suppliers

Producer

B. Raw Material Supply Hub Raw Material Suppliers

Component Suppliers

2 Markets

Producer

Markets

3

With regard to internal processes, organizations can obtain a variety of benefits (e.g., productivity, employee goodwill, reputation enhancement, etc.) by employing a private network ecosystem solely inside their boundaries. The platforms used with such internal marketplaces can be developed in-house or licensed from a third-party platform-provider. A nice example of using a private market ecosystem is that of Zimride, the ride-sharing platform that Lyft’s founders licensed to universities and businesses as a private ride-sharing service used solely by a subscribing university’s/business’s employees.37 Zimride provides a useful benefit for employees in the form of a convenient and safe mechanism for solving employees’ commutingto-work problems and positions the organization as being socially-responsible, a quality likely valued by many of the organization’s stakeholders.

R. Lawler, “Lyft-Off: Zimride’s Long Ride to Overnight Success,” TechCrunch, August 29, 2014: https://techcrunch.com/2014/08/29/6000-words-about-a-pink-mustache/ 37

148

With regard to downstream processes, Table 6-4 provides examples of three organizations that have appended C2C marketplaces as complements to their traditional sales channels.

When carefully conceived and executed, the network

effects engendered can be exploited to enrich a brand and grow the consumer base without cannibalizing pre-existing sales channels. Table 6-4 Introducing a C2C Marketplace into a Pipeline Ecosystem Value Stream Pipeline Organization Ikea Group

Patagonia

DM

(German Drugstore Chain)

Network Ecosystem Ikea Family loyalty program

community: members post & sell used Ikea items.

Strategic Value  Supports Ikea’s eco-friendly ethos.  Opens up room in members’ homes for new Ikea items.

Partnership with eBay: consumers easily sell used Patagonia clothing items.

 Supports Patagonia’s eco-friendly ethos.  Increases the visibility of the Patagonia brand both online and on the street.

Sponsors & arranges clothing swap events, at which makeup/styling products & techniques are demonstrated.

 Generates new consumers in the targeted demographic.  Enriches brand by leveraging the green spirit of sharing rather than buying.  Gains brand visibility as these events are featured on social media and by fashion bloggers.

A Recap and Look Ahead Network ecosystems, as introduced and fleshed out in this chapter, represent a rapidly increasing segment of most countries’ GNPs.

In the process, existing

markets and industries are being transformed and new markets and industries are being formed. The next chapter examines the digital strategy formulation process for network orchestrators, regardless if a network orchestrator offers a market platform for a public or private network ecosystem.

149

Chapter 7. Digital Strategy Formulation for Network Organizations

Within a network ecosystem, market participants connect and conduct interactions with one another using a market platform provided by a network organization – the network orchestrator. While interacting, market participants make use of platform content/functionality to exchange data, exchange items of value (e.g., value-units, monetary payments, etc.), and collaborate in co-creating new value-units. This

chapter

discusses

digital

strategy

formulation

within

network

organizations. Because of the huge variety of network ecosystems, our discussion will be in the form of general concepts and frameworks – that are then grounded through two different network organizations (see Figure 7-1 and Table 7-1): TopCoder38,39 and Metropia40.

TopCoder is an established organization that has

constituted a single network ecosystem handling all of TopCoder’s work activities; Metropia is a relatively young organization that aims to constitute many local (geographically-bound) network ecosystems.

H. Tajedin and D. Nevo, “Value-Adding Intermediaries in Software Crowdsourcing,” 47th Hawaii International Conference on System Sciences, IEEE, January 2014, pp. 13961405. 39 H. Tajedin, D. Nevo and R.W. Zmud, “Beyond Matching: Intermediaries’ Market Design and Market Development Roles in Software Development Crowd Markets,” working paper, Rensselaer Polytechnic Institute, January 2017. 40 The Metropia material has been gathered by one of this book’s authors through interviews with two members of Metropia’s leadership team, including the founder/CEO. 38

150

Figure 7-1 The Communities Participating in TopCoder and Metropia Metropia

TopCoder

Commuters Developers

Clients

Mobility Service Providers

Government Agency

Merchants

Market Platform

Market Platform

Table 7-1 Describing and Contrasting TopCoder and Metropia TopCoder

Metropia

Core Transaction

Delivering a solution (software code) that satisfactorily meets a client’s specification (a software project)

Provide an optimal mobility solution for moving the commuter from point A to point B

Community 1

Clients (money-side)

Commuters (money-side)

Community 2

Developers (subsidy-side)

Mobility Providers (subsidy-side)

Community 3

Merchants (subsidy-side)

Community 4

Government Agencies (money-side)

Market Geographic Scope

Global

Local

Maturity

Established

Young

Founded in 2001, TopCoder offers crowdsourced software design and development services to (mostly North American Fortune 500) clients across numerous industries.

As of May 2015, TopCoder had built a community of over 151

700,000 developers, of which nearly 20% were active. Metropia was founded in 2010 as a Mobility-as-a-Service (MaaS) platform for commuters in congested urban areas. At the time this case material was collected, Metropia was in five urban areas (Austin, El Paso, Houston, New York City and Tucson) and was in various stages of rolling out platforms in five additional urban areas. The chapter introduces intuitive ways of thinking about the digital strategies formulated by network organizations as they establish and evolve network ecosystems by covering the following topics: 

Business Models for Network Organizations



Strategic Intent for Network Organizations



Market Design and Market Platform Design



Digital Strategy Formulation



Sustaining a Network Organization’s Market Position

Business Models for Network Organizations Business models for network organizations (see Figure 7-2) differ from those of pipeline organizations in two primary ways: 

The presence of an additional business model element – the number of communities interacting through a network organization’s market platform.



The existence of a unique value proposition and a unique profit model for each of the interacting communities.

Typically, two of these interacting communities are directly associated with the core transaction: the producer and the consumer of the value-unit(s) being exchanged via the constituted market. Other interacting communities are then attracted by the opportunity to touch producer participants, consumer participants, or both.

A

network organization’s success is ultimately linked to (1) the (continuing) presence 152

of engaging value propositions for each of the interacting communities, and (2) a set of community profit models that additively produce a profitable revenue stream. Figure 7-2 Business Models for Network Organizations

Community Value Propositions

Community Profit Models

Number of Communities

Core Capabilities

Dynamic Capabilities

Similar to pipeline organization business models, network organizations deliver value propositions and profit models through sets of core capabilities and dynamic capabilities. As might be expected, these capabilities tend to vary somewhat with regard to the community (or communities) being targeted. Consequently, capability development and management requires the balancing (for effectiveness and efficiency purposes) of local (a single community) and global (all communities) interests. Table 7-2 provides an overview of TopCoder’s business model.

Here,

tournament-style crowdsourcing is applied to incentivize a developer community (the producer) to deliver software solutions (the value-unit) to a client community (the consumers). Importantly, the client community is the money-side of the market, while the developer community is the subsidy-side.

Client software projects are

broken into a series of contests (project specification, architecture design, version 153

specification, version design, version coding/testing, etc.), with three (or so) winning solutions selected for each contest. The client accepts one of these winning solutions as the overall winner and the project-related work then moves on to the next contest. The core transaction is contest design and fulfillment – the delivery of a satisfactory contest solution to a client. Table 7-2 TopCoder’s Business Model Business Model Element

Description

Client Community Value Proposition

Obtain quality code (e.g., tested against specifications, secure, etc.) within agreed-on schedule and budget.

Client Community Profit Model

 Clients pay subscription fee.  Clients provide contest incentives (payments to winning developers).

Developer Community Value Proposition

Earn income, acquire new skills, demonstrate skills and interact with forward-looking technologists.

Developer Community Profit Model

No associated revenue stream (the developer community is the subsidy-side of this network ecosystem).

Core Capabilities

 Software development & software development management.  Translating software development projects into contests.  Contest design & fulfillment.  Acquiring, developing and retaining community participants.  Creating a sense of community for participants.

Dynamic Capabilities

 Sensing & identifying software development trends & innovations.  Sensing & identifying new participant sources.

Metropia’s business model (summarized in Table 7-3) is more complex. The core transaction involves a commuter desiring to move from point A to point B by selecting one of a number of offered mobility solutions: self-navigation (driving, walking, bicycling), toll roads, car-pooling, ride-sharing, car-sharing, bike-sharing, ride-hailing, various mass transportation modes, etc. The mobility service portfolios vary across the local market platforms, and the offered solutions are produced through the application of sophisticated traffic algorithms on massive collections of historical and streaming traffic-related data. The commuter earns reward points for selecting solutions that contribute to the common good, and these reward points are 154

exchanged for goods/services at participating merchants.

Each local platform is

supported by one or more governmental agencies, motivated by a desire to improve the transportation common good by changing commuter behaviors and by obtaining enhanced capabilities for collecting and analyzing transportation-related data. Table 7-3 Metropia’s Business Model Business Model Element Commuter Value Proposition

Commuter Profit Model Provider Value Proposition

Provider Profit Model

Description  Provide optimal mobility solutions for going from point A to point B.  Provide reward points for contributing to the common good .

 Subscription fees & transaction fees.  Gain exposure with the commuter community.  Gain revenue from servicing the commuter community.

 Negotiated mobility services costs.

Merchant Value Proposition

 Build reputation with commuter community.

Merchant Profit Model

 Exchange goods/services for reward points.

Government Agency Value Proposition

 Enhance commuting common good.  Obtain mobility-related data.  Obtain knowledge from Big Data analytics.

Government Agency Profit Model

 Revenue (from developing, launching & enhancing local market platforms).  License fees (from Big Data/analytics products & services).

Core Capabilities Dynamic Capabilities

 Traffic optimization & Big Data analytics.  Interconnect market platform with government/provider processes.  Relationship management (all communities).  Sensing and identifying new mobility services and providers.  Sensing and identifying new government regulations.

Strategic Intent for Network Organizations A strategic intent directs, rather than constrains, organizations’ digital strategists’ thought processes as competitive actions are formulated and as the capabilities necessary for implementing these and future competitive actions are developed. With pipeline ecosystems, strategic intents are established to emphasize and evolve a dominant consumer value proposition – and, hence, the capabilities that enable the value disciplines (i.e., operational excellence, customer intimacy and/or product leadership) that underlie this value proposition.

Given the multiplicity of

value propositions that co-exist with network ecosystems, these organizations’ 155

strategic intents tend to be considerably broader than those of their pipeline organization counterparts. In essence, network organizations’ digital strategists face a more complex and more dynamic competitive space than do pipeline organizations’ digital strategists - think about not only juggling more balls, but balls that are erratically moving about. Table 7-4 illustrates the primary value propositions offered by TopCoder and Metropia.

As suggested, all three value disciplines are critical to the competitive

success of both of these organizations. Table 7-4 TopCoder’s and Metropia’s Value Propositions

Community

Value Proposition

Clients

Obtain software code that meets specifications within agreed-on schedule & budget.

Value Disciplines Operational Customer Product Excellence Intimacy Leadership

TopCoder

Developers

Earn income, develop skills, demonstrate skills and interact with forward-looking community.

Commuters

Obtain optimized mobility solutions & reward points.

Metropia

Providers

Gain exposure to and services revenue from the commuter community.

Merchants

Build reputation within the commuter community.

Government

Enhance the transportation common good, access a new source of traffic data, and enhance Big Data analytic capabilities.

Market Design and Market Platform Design The competitive moves taken by a network organization’s leadership team can be viewed, conceptually, as focused on one of two levels of design: market design, or moves aimed at enhancing the efficiency of the constituted market; and, market platform design, or moves aimed at building market platform content/functionality 156

in order to enhance community participants’ satisfaction with offered value propositions.

Table 7-5 describes each of these design levels by providing the

primary attributes serving as each level’s focus and offering examples of competitive moves addressing these attributes.

While moves taken at either of these design

levels can affect both market efficiency and participants’ satisfaction, distinguishing competitive moves in this manner can ease the cognitive and communication efforts of leadership team members and of digital strategists as they formulate their organizations’ digital strategies. It is also important to note that taken competitive moves can be initially implemented by fully-digitalized processes (i.e., built into a platform’s functionality) or by staff being supported through digitalized processes. Over time, the operational and managerial processes associated with competitive moves handled initially by humans are typically digitalized as the processes are institutionalized. Table 7-5 Market Design and Platform Design Attribute

Targets of Competitive Moves Market Design

Market

 Recruitment of community members.  Retention of community members.

Market

 Maintenance of an effective balance in community sizes.  Occurrence of value-adding matches.

Thickness

Congestion Market

Safety

 Perceived fairness & trustworthiness of market transactions.  Perceived trustworthiness of platform content.  Perceived level of platform security.

Market Platform Design Core Transaction Fulfillment Ease-of-Use Data & Information Exchange Adaptability

 Core transaction fulfillment rate.  Participants’ satisfaction with community value propositions.  Participants’ abilities to access platform functionality & content.  Participants’ abilities to contribute data & information.  Participants’ abilities to interact with other participants.  Ease of adding or removing: communities, participants, platform functionalities & platform content.

157

Market Design The objective of market design is to create the conditions most conducive to efficient market operation.

Three such conditions are suggested as being most

important:41,42 

Market thickness: ensuring sufficiently large numbers of producers and consumers such that a strong likelihood exists that satisfactory producerconsumer matching will occur.



Market congestion: ensuring the ease by which producers and consumers are able to consider a sufficient number of alternatives in arriving at a satisfactory match.



Market safety: ensuring that market transactions are sufficiently safe such that producers and consumers are willing to reveal or act on confidential information and are willing to keep the transactions inside the market.

Let’s now look more closely at each of these market design attributes. A classic example for understanding market thickness is that involving credit cards. What do you, as a consumer, value in a credit card? While things like reward programs and interest rates are obviously important, you would not even consider a credit card unless it was accepted by most of the merchants you patronize. What leads a merchant to decide to accept a specific credit card? While setup costs and transaction fees are clearly important, a merchant would hesitate to invest in a card that was not held by a sizeable portion of the merchant’s customers. Invariably, the decision by producers or consumers (or, in general, market participants) to join a specific network ecosystem is largely a function of the size of the cross-side community. Successfully resolving this chicken-and-egg problem represents a major

A.E. Roth, “What Have We Learned from Market Design?,” The Economic Journal, March 2008, pp. 285-310. 42 H. Tajedin, Three Essays on Crowdsourcing as a New Mode of Organizing, 2016 Doctoral Dissertation, Schulich School of Business, York University, Toronto, CA. 41

158

challenge for network organizations. Further, because of the learning costs borne by participants engaging with a new market platform, ensuring sufficient market thickness requires a simultaneous focus on attracting and on retaining participants. Your first thoughts when hearing the term congestion is likely to bring up images of difficulties faced by participants as they navigate through a market platform in order to locate attractive value-unit matches.

While such navigation

challenges can certainly deter market platform use and hinder market efficiency, market congestion tends to be most problematic when the demand for available value-units is highly skewed, resulting in too few participants being able to satisfy their needs through a marketplace.

To counter demand skewness, network

orchestrators need to undertake initiatives aimed at balancing demand by (1) attracting or developing producers of the in-demand value-units, and/or (2) educating consumers on how available value-units in less demand might as well satisfy their needs. Many potential threats to market safety arise when market participants interact and carry out transactional exchanges via a market platform, such as: 

Is my exchange partner trustworthy?



Is the market platform content trustworthy?



Will all data or information I provide in carrying out a market transaction be treated in a confidential and protected manner?



Will the value-unit(s) delivered to me meet my expectations?



Will the value-unit(s) delivered to me be free of intellectual property or licensing concerns?



Can I be confident that financial exchanges will be carried out in a secure and protective environment?

159

If potential market participants develop safety-related concerns, one of two things is most likely to occur. First, many of these potential participants will simply decide not to participate. Second, many of the participants who do decide to participate will end up identifying, but not consummating, a match; instead, matched participants will be motivated to consummate the match (along with associated revenue streams) outside the market platform. Many of the competitive moves taken by TopCoder and by Metropia have been aimed at enriching market design, with associated market platform functionality put in place to enable or support the taken moves. Tables 7-6 and 7-7 illustrate these market design competitive actions for, respectively, TopCoder and Metropia. Table 7-6 TopCoder’s Market Design Competitive Moves

Primary Processes

Market Design Attribute

Grow Developer Community

Thickness

 Talent teams engage in on-campus campaigns.  Talent teams run algorithm challenges (competitions).

Grow Client Community

Thickness

 Sales teams target, market to and interact with potential clients.

Enrich Developer Skills

Congestion

 Account teams induce clients to offer projects requiring hot skills.  Internal R&D offers projects requiring hot skills.

Enrich Client Demand

Congestion

 Account teams broaden clients’ views of what can be done via software development crowdsourcing and on the crowds’ capabilities.

Match Developers with Contests

Congestion

 Account teams work with clients to break projects into contests.  Account teams modify contests not attracting sufficient developers.

Enrich Solution Fulfillment Safety

Safety

Retain Developers

Thickness

 Contest reviews & project management increasingly outsourced to the developer community.  Enrich the developer community through events & developer forums.

Retain Clients

Thickness

 Long-term contracts, strong client relationships, and the provision of rich metrics regarding contest, project & client success.

Competitive Moves

 Staff managers and developer co-pilots monitor projects & contests.  Staff & developer-crowd assess solution completeness/trustworthiness.  Contest appeals process for non-winning developers.

160

Table 7-7 Metropia’s Market Design Competitive Moves Market Design Attribute

Competitive Moves

Grow Commuter Community

Thickness

 Partner with government agency in promoting platform.  Partner with an organization sponsoring a traffic-congesting event to promote platform.

Add a Provider

Thickness

 Leverage government agency (permitting & regulatory) relationships with providers.

Grow Government & Merchant Communities

Thickness

 Establish program managers/teams.

Enrich Commuter Perspectives

Congestion

 Programs directed at broadening commuters’ understandings of mobility alternatives.

Enhance Data/ Algorithms

Congestion

 Continual improvement

Primary Processes

 Reengineer reward points schemes, processes & algorithms to detect and to prevent fraud.  Commuter data shared only in aggregate forms.

Enhance Platform Safety

Safety

Retain Commuters

Thickness

 Threat of losing accumulated reward points.

Retain Government Agencies

Thickness

 Threat of losing data/analytic capabilities.

Market Platform Design: Digitalizing the Operational Domain Table

7-8 describes

five

major operational purposes

of

all network

organizations’ market platforms. Most of the activities listed should be familiar to you, but one may not: ancillary transactions.

As explained earlier, the core

transaction refers to the market exchanges that bring a producer community and a consumer community together.

Ancillary transactions refer to transactions

associated with the value propositions that bring communities other than producers and consumers to the platform. Perhaps the most familiar example of this distinction can be seen with Google.

Google’s core transaction involves finding satisfactory

matches between consumers’ search cues and producers’ website content. Google’s ancillary transactions involve the placing of and clicking on the advertisements that show up along with search results. 161

Table 7-8 Operational Purposes of Network Organizations’ Market Platforms Platform Purpose

Associated Activities

Community Hosting

 Adding a new community.  Removing an existing community.

Community Member Hosting

 Adding a new community participant.  Providing functionality & content through which participants can develop & promote their needs & capabilities.  Removing an existing community participant.

Matching Facilitation

 Providing functionality & content enabling participants to identify matches aligned with sought value propositions.  Providing functionality enabling participants to select a match.

Core Transaction Facilitation

 Providing functionality & content to negotiate & execute transactions.  Providing functionality & content to verify completed transactions.

Ancillary Transaction Facilitation

 Providing functionality & content to negotiate & execute transactions.  Providing functionality & content to verify completed transactions.

A number of critical operational performance requirements are reflected in Table 7-8: ease-of-use (simplicity, multi-channel convenience, mobility and flexibility),

efficiency

in

executing

platform

functionalities,

cost-effectiveness

(especially with regard to subsidy-side communities), scalability (as communities grow

rapidly),

and

adaptability

(adding/removing

communities,

participants,

functionalities and content). Collectively, these performance requirements dictate that network organizations’ market platforms adopt particular architectural features: many-to-many connectivity, modularity, the tight-coupling of modules delivering global (i.e., used by multiple communities, including internal staff) functionalities, and the loose-coupling of modules delivering local (i.e., used by a single community) and experimental functionalities.

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Market Platform Design: Digitalizing the Analytical Domain The nature of network ecosystems – that is, communities with large numbers of members, participants’ interaction within and between communities, participants’ navigation through the market platform provided by a network orchestrator, participants’ transaction exchanges, etc. – results in the capture and generation of huge amounts of data. These data can then be stored and organized for a variety of analytical purposes, including: 

Learning about each community in order to better understand and anticipate community members’ capabilities, perspectives, desires, needs and expectations in order to grow/retain community members, to enhance value propositions and to enhance profit models.



Learning about participants’ platform navigation behaviors, as well as participants’ use of platform functionality and content, in order to improve ease-of-use, to enhance community value propositions and to enhance profit models.



Learning about the core transaction and, if they exist, ancillary transactions in order to better understand, improve and predict fulfillment success in order to enhance value propositions and to enhance profit models.

Importantly, the capabilities fashioned to undertake such analyses can be used by network organization staff and by participants. Figures 7-3 and 7-4, respectively, illustrate some of the ways in which TopCoder and Metropia are digitalizing the analytical domain.

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Figure 7-3 Digitalizing the Analytical Domain at TopCoder Project Data

Client Profiles Developer Profiles

Contest Data

Primary Process Performance Data

Example Core Data

Diagnosing & predicting the success of a proposed project. Prescribing how projects should be broken up into contests. Predicting contest success and prescribing contest modifications. Metrics production for contests, projects, clients, developers & matching.

Example Analytic Processes

Project, contest & matching post-mortem analyses to identify areas for primary process improvements and to identify hot developer skills.

Figure 7-4 Digitalizing the Analytical Domain at Metropia

Commuter Profiles Merchant Profiles

Mobility Provider Profiles

Streaming Transportation Data

Historical Transportation Data

Commuter Services Usage Data

Commuter Trip, Common Good, Provider & Merchant Outcomes

Example Core Data

Traffic flow modeling – overall and for each mobility service. Scheduling routines – overall and for each mobility service. Routing routines – overall and for each mobility service. Determining reward points for commuter trip selections.

Example Analytic Processes

Commuter behavior modeling.

Market Platform Design: Digitalizing the Collaborative Domain A primary function of network organizations’ market platforms involves the facilitation of information exchanges – between community members, between the 164

members of different communities, and between network organization staff and members of different communities. These information exchanges are crucial, as such exchanges enable participants to learn about offered value propositions and to decide whether or not to participate further (and, ultimately, take advantage of offered value propositions). These information exchanges occur through one-to-one, one-to-many and many-to-many connections. Importantly, establishing a connection involves much more than providing the necessary connectivity. As these information exchanges tend to be directed toward specific purposes (e.g., exploring or negotiating a potential match, learning more about a value-unit or value-proposition, co-creating an idea or value-unit, etc.), sophisticated digitalized collaboration environments are established – environments characterized by specific functionalities, content and behavioral rules. Given the heterogeneity present across the members of most interacting communities,

a

variety

of

collaboration

modes

(messaging,

social

media,

conferencing and collaboration tools) are typically provided to participants. Tables 7-9 and 7-10, respectively, illustrate some of the digitalized collaboration environments that have proved invaluable for TopCoder and Metropia.

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Table 7-9 Digitalizing the Collaborative Domain at TopCoder Collaboration Environment

Examples

Messaging & Conferencing

 Peer-to-peer messaging: client/developer, staff/client, staff/developer, staff/staff, and developer/developer  Forums: client/developer, staff/client, and staff/developer.

Ideas Processing  Identifying hot technology trends & skills. Joint-Work Space

 Project & contest monitoring.  Project design (contests, deliverables).  Contest software design (specifications, architecture).  Contest software coding/testing.  Assessing contest solution completeness & trustworthiness.  Setting contest incentives.

Decision-Making  Modifying contests & contest incentives. Processes  Ranking contest solutions (selecting winners).

Table 7-10 Digitalizing the Collaborative Domain at Metropia Collaboration Environment

Examples

 Peer-to-peer messaging: commuter/commuter, staff/commuter, staff/government, staff/provider, and staff/merchant.  Forums: staff/commuters and staff/government. Social Network  Commuters.  Real-time resolution of traffic congestion hot spots.  Improving algorithm accuracy & reliability. Joint-Work  Big Data analytics: staff/staff and staff/government. Space  Market platform functionality development.  Promotional campaigns.  Reengineering of reward schemes. Decision-Making  Product launch. Processes  New market platform (urban area) launch.

Messaging & Conferencing

Digital Strategy Formulation The task facing network organizations’ digital strategists is quite daunting. In addition to having to confront many of the same strategic challenges as those facing pipeline organizations’ digital strategists, network organizations’ digital strategists have to design and build a market ecosystem from scratch and motivate participants 166

to engage in value-unit exchanges through the market platform. The heightened complexity facing network organizations’ digital strategists is perhaps best understood through the five strategic challenges summarized in Table 7-11.

We

begin this section by discussing these five strategic challenges. Then, we describe how digital strategists evolve their organizations’ business models. Table 7-11 Network Organization Strategic Challenges Strategic Challenges How fast should each community grow? Which pricing mechanisms should be applied to each community? Should a new feature be added? Should transactions and participant behaviors be regulated? How many communities should connect to the business platform?

Key Issues  How can we overcome the chicken-and-egg challenge?  Is it possible to exploit side-switching?  How can we keep a balance in community sizes?  Which communities should be subsidized and which represent viable sources of profit?  How will a particular pricing mechanism affect participant behavior or community growth?  Should price-differentiated functionality levels be used?  Is the expected benefit greater than the expected cost?  Will one or more communities be negatively affected?  Which types of market failures are most likely to occur?  Which community members should be allowed to join?  What should members of each community be able to do?  How does the presence of a community influence other communities’ value propositions?  How does the presence of a community affect platform complexity?  What is the economic viability of a community?

How Fast Should each Community Grow? When a network organization first launches its market platform, the first hurdle to overcome is the chicken & egg problem: producers only wish to participate in a market with a large pool of potential consumers, and consumers only wish to participate in a market with a large pool of potential producers.

Table 7-12

summarizes a selection of tactics that can be used to resolve this chicken & egg

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problem.43 And, in certain situations, growth can be accelerated by promoting sideswitching.

With side-switching, existing producers become consumers and/or

existing consumers become producers (e.g., with Airbnb, short-term renters often decide to become hosts, and hosts often become short-term renters). Table 7-12 Tactics for Overcoming the Chicken & Egg Problem Tactic Follow-the-Rabbit

Piggy-Back

Description Build a producer community by incenting members to create value-units, which in turn will attract a consumer community. Connect with members of an existing community - either a producer community to gain access to value-units or a consumer community (if value-units already exist).

Seeding

Attract an ancillary community by first growing the producer and/or consumer community to which the ancillary community is attracted.

Marquee

Provide incentives to attract highly-visible and influential participants (producers or consumers), whose presence attracts other participants.

Pipeline

Begin as a pipeline organization to build a targeted producer or consumer community; then, attract other communities desiring to interact with this first community.

Big-Bang Marketing

Invest heavily in traditional push marketing strategies to attract the communities critical to the in-play business model.

Micromarketing

Begin by targeting a niche market whose producer & consumer communities are already interacting.

However, if one side grows too fast, negative network effects are felt: too many consumers leads to insufficient supply, resulting in unsatisfied consumers; too many producers leads to insufficient demand, resulting in unsatisfied producers. It can be difficult, if not impossible, to retain or to regain an unsatisfied participant. How can the threat of negative same-side network effects be managed?

Three

common tactics are (1) invest in growing an undersized community, (2) impose rules

G.G. Parker, M.W. Van Alstyne and S.P. Choudhury, Platform Revolution: How Networked Markets are Transforming the Economy – And How to Make Them Work for You, 2016, New York: W. W. Norton. 43

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that constrain the behaviors of members of the oversized community (e.g., limit the number of allowed transactions), and (3) segment the market so as to increase the likelihood of successful matches within each segment. What Pricing Mechanisms Should Be Applied to each Community? With few exceptions, communities are brought to a network organization’s market platform for one of two reasons: to serve as a revenue source (a moneyside), and to attract other communities that can serve as revenue sources (a subsidyside). Determining an appropriate profit model for each community is critical because of the powerful growth dynamics of network ecosystems: 

Charging (or charging too much) for access will limit or reduce community size.



Charging (or charging too much) for feature use will inhibit participants’ engagement with the business platform.



Charging (or charging too much) for value-units will reduce demand.



Charging (or charging too much) for production will reduce supply.

Generally, pricing mechanisms are imposed on the members of a community when these members are able to use the market platform to extract value from the members of another community.

The greater the value being appropriated, the

greater the price that can be imposed. Often, pricing mechanisms can also be imposed on subsidy-side communities, providing a revenue stream from the subsidy-side.

This can occur if the value

proposition is highly-attractive and unique (i.e., not available elsewhere), and if these subsidy-side community members are likely to accept some level of access/usage charges. That said, it is wise to never charge any participant for services he/she has become accustomed to receiving for free. Instead, add new features to the value 169

proposition, attach the charges to these new features, and continue to make the base-level (initial) features available for free to community members. Should a New Feature Be Added? An infinite variety (limited only by creativity and capability) of new, ideally innovative, features can be added to a market platform to enhance the value propositions offered to the platform’s interacting communities.

Generally, these

deliberations about new features are quite straightforward: add any new feature whose acquisition and implementation costs are less than the value being created. However, if the new feature being considered is not viewed as a benefit by all communities or, even worse, if the new feature portends to bring some participants in conflict with other participants, this decision can become quite challenging. In such situations, the trade-offs to be reasoned across communities can be extremely difficult to navigate, especially prior to the new feature’s actual implementation. For this reason, network organizations often engage in strategic experimentation to assess the likely impacts of new platform features. With a strategic experiment, a new feature is implemented – but only for a limited set of participants and a limited set of transactions – and relevant data is captured that can be analyzed in determining the positive and negative impacts of the feature.

Further, digital

strategists need to recognize that short-term revenue gains (from one community) may need to be bypassed so as not to alienate participants (from another community) and that it is not always best to favor the community that brings in the largest share of current revenues, as this community may not be the most important source of future revenues.

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Should Transactions and Participant Behaviors Be Regulated? Some regulation is indispensable as a means for preventing market failures, i.e., an improperly-functioning (or collapsing) network ecosystem: 

Insufficient information and transparency in the market with respect to the value-units and payments being exchanged can result in low-quality participants driving out high-quality participants.



Excessive competition within an interacting community or an unwillingness by a community’s members to maintain their capabilities reduces the value being created in the market and, hence, the market’s attractiveness to other interacting communities.

Accordingly, network organizations develop regulations targeted at participants’ use of a market platform’s content and functionalities. These regulations are most often imposed to force a trade-off of quality over quantity. The strength of any cross-side network effect is ultimately a function of the number and the quality of the market exchanges taking place. If, over time, a growing proportion of market exchanges are seen by participants as decreasing or of low quality, the positive cross-side effect will attenuate – eventually becoming a negative cross-side effect that results in the market’s collapse. How Many Communities Should Connect to the Market Platform? The advantages of attracting a new community to a network ecosystem’s market platform are often very appealing to digital strategists. The addition of a new community raises the promise of additional positive cross-side network effects, the promise of a new revenue source, and the promise of greater scale. However, adding a new community does not always result in positive outcomes. If not mindfully thought out and carefully timed, a new community can produce: negative cross-side network effects (when the new community’s value 171

proposition conflicts with aspects of the value propositions of one or more existing communities), increased operational and strategic complexity, and increased operational costs. Further, a tendency exists for innovativeness to be dampened as additional communities are added. Here, the radicalness of a functional innovation targeted at one community is toned down to maintain the acceptability of the functionality to other communities, appropriating little value from this functionality enhancement. Evolving Network Organizations’ Business Models The strategic challenges summarized in Table 7-11 serve as a backdrop that pervades digital strategists’ deliberations as they evolve their organizations’ business models via competitive moves targeting market design, market platform design, or both.

Figure 7-5 overviews the factors typically considered in fashioning specific

competitive moves. Figure 7-5 Factors Driving Business Model Evolution

Strategic Intent Beliefs about:  Communities’ needs & desires  The core transaction & adjacent transactions  Same-side & cross-side network effects  Core capabilities  Dominant value discipline(s)

 Natures of adjacent (competitive & substitute) markets  Adjacent market business model innovations  Socioeconomic & cultural trends

Business Model Deliberations  Number of communities  Value propositions  Profit models  Core capabilities  Dynamic capabilities

Business Model Evolution

 Installed platforms  Held digitization capabilities  New digital technologies  Others’ digitalization innovations

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A taken competitive move typically affects multiple elements of a business model.

Table 7-13 organizes a sample of TopCoder’s competitive moves by the

primary business model element affected. Examples of this include: 

Having platform-related R&D carried out by the developer community via contests both incents developers to participate in the market and develops their capabilities. In addition, the R&D project outcomes produce functionality improvements that can enhance the client communities’ value proposition, as well as TopCoder’s capabilities and the community profit models.



Providing incentives for non-winning developers clearly enhances the developer community value proposition, thus finding more developers willing to invest their time and effort in contests (and in the process honing their capabilities by participating in a greater variety of contests). The client community value proposition is also enhanced, as retaining and honing the capabilities of the developer community increases the likelihoods that matches will be found for clients’ projects and that these projects will be satisfactorily fulfilled. Finally, by growing the developer and client communities and by improving project fulfillment rates, TopCoder’s community profit models are likely to improve.

The above examples illustrate that a taken action targeted at one purpose often spills over to affect other purposes. It is important to remember that such spillovers are not always positive. Clearly, fashioning successful competitive moves for network organizations requires considerable analysis – that often must be performed quickly and imprecisely given the fast-moving dynamics of network ecosystems.

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Table 7-13 Examples of TopCoder’s Competitive Moves Business Model Element Communities

Business Model Evolution None observed.

Value Propositions

Profit Models

 Platform R&D carried out as contests.  Transferring software development management tasks (contestco-pilot, solution assessment, solution appeals process, etc.) to the crowd.  Incentives to ensure winners of a project’s completed contests are available to interact with participants in the project’s subsequent contests.  Crowd-engaged appeals process regarding winning solutions.  Imposing a 30-day time period for vetting winning solutions.  Incentives provided for non-winning developers.

Core Capabilities

Dynamic Capabilities

 Contest success prediction.  Contest fulfillment.  Client capability development.  Crowd skill development.  Develop crowd into a community. None observed.

Table 7-14 similarly lists some of Metropia’s competitive moves directed at specific business model elements.

Which of these are likely to spillover to other

business model elements? Table 7-14 Examples of Metropia’s Competitive Moves Business Model Element

Business Model Evolution

Communities

 Host private mobility service markets (e.g., car-pooling, ride-sharing, etc.) for use by a specific organization’s employees.

Value Propositions

 No platform subscription fees for commuters at initial launch.  Develop a personalized mobility health checkup functionality that uses data on a commuter’s commuting behavior to broaden the commuter’s mobility perspectives and to offer the commuter customized trip solutions.  Customized consulting services for government agencies.  Customized performance reports provided to participating commuters, providers, merchants & government agencies.

Profit Models

 Commuter subscription fees added as a local platform matures, the platform’s portfolio of mobility services broadens, and commuter platform interactions are personalized.

Core Capabilities

Dynamic Capabilities

 Big Data transportation analytics consulting services.  Commuter & government agency capability development. None observed.

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Sustaining a Network Organization’s Competitive Position Two pathways exist for sustaining a network organization’s market position, with the preferred path depending on whether or not winner-take-all market dynamics apply: 

Winner-take-all market dynamics - apply: act quickly to become one of the two or three dominant firms in the market space and then sustain this market position.



Winner-take-all market dynamics - do not apply: grow both the market space and the firm’s share of the market space more deliberately by evolving a business model that becomes increasingly attractive to all interacting communities, and then sustains (or increases) this market position.

Our focus here is on sustaining a strong market position in the face of the constant threat of digital disruption, regardless of the above market-position pathways. Perhaps this most important insight for digital strategists is the realization that a focus on just amplifying positive cross-side network effects cannot guarantee the barriers to entry that protect a firm from existing competitors and from new entrants. Attention must also be directed at finding ways to: 

Impose switching costs on participants.



Drive down market platform costs (the average costs to host communities, to facilitate participant interactions, and to execute transactions), thus making it cost-prohibitive for new entrants to enter the market space.



Continuously improve market platform ease-of-use.



Introduce business model innovations, especially those related to community value propositions and profit models.



Quickly imitate (ideally with enhancements) competitors’ and new entrants’ business model innovations.

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Network ecosystems are powerful and hard-to-replicate because of their inherent community dynamics.

However, achieving and then sustaining a strong market

position is difficult, requiring high levels of both strategic vigilance and creativity. A Recap and Look Ahead While network organizations represent a smaller share of nations’ GNPs than do their pipeline organization counterparts, this rapidly growing segment of most nations’ economies is spurring much of the digital innovation (and digital disruption) being observed today. This chapter has described how digitalization is applied within network organizations, as well as the processes used by network organizations to formulate their digital strategies. While well-reasoned digital strategies have become a dominant driver of competitive success for both pipeline organizations and network organizations, the pervasive digitalization that results can raise serious threats for organizations’ leadership teams. The next chapter examines these threats, and the tactics being applied to attenuate the threats.

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Chapter 8. Grappling with the Risks of Digitalization

The enabling nature of digital disruption might best be captured by three ideas: pervasive digitization, pervasive connectivity and pervasive mobility.

Invariably,

pipeline ecosystem participants and network ecosystem participants find themselves constantly accessing and exchanging digitized content (e.g., data, information, goods, services and currencies) and it is precisely these type of activities that are creating an abundance of competitive opportunities for digital strategists able to act smartly and nimbly. However, the technological underpinnings of organizations’ digital strategies also pose significant strategic risks.

If digitalization risks are not appropriately

addressed by organizations’ leadership teams, the competitive wins that are realized are likely to be short-lived, at best. Consider what happened in January 2003 when a small (376 bytes) data virus infected a single processing device with the Slammer worm.44 After launching itself onto the Internet, it infected close to 100,000 large computer systems worldwide in just 30 minutes. The impact was chilling: air and rail transport were delayed, electrical and pipeline utilities were interrupted, ATMs were disabled, call centers were shut down, etc. In today’s highly digitized, connected and mobile world, a single person’s lapse can quickly spread across the platforms to which the person is directly or indirectly connected. Nothing demonstrates the challenges presented to digital strategists better than the paradox surrounding the capture and use of personal data. Data privacy

T. Goles, G. White and G. Dietriech, “Dark Screen: An Exercise in Cyber Security,” MIS Quarterly Executive, June 2005, pp. 303-318. 44

177

concerns exist wherever personally-identifiable or other sensitive information is captured, collected, stored and used. That said, tomorrow’s waves of digitalization innovation and growth will surely involve intelligent analytics, highly-customized goods and services, and always-available mobile connectivity offering one-touch transactions, where these transactions require the collection and use of vast quantities of personal data: socio-demographic data, location data, transaction histories, etc. People can be motivated – through the expectation that the value of the goods and services obtained will outweigh potential liabilities – to allow the capture and collection of these data, but only if trust is established and maintained that any collected personal data will be protected and will not be used in the absence of permission to do so. A key factor differentiating those organizations able to successfully exploit digitalization for competitive purposes is a set of strong capabilities for managing digitalization risk. Supporting evidence for the value of managing digitalization risk is illustrated by a study that found voluntary disclosures of initiatives aimed at reducing digitalization risks improved organizations’ stock prices by, on average, 6%.45 Effective digitalization risk management, however, involves much more than enhancing an organization’s cybersecurity.

The real challenge is to achieve an

effective balance in stability (as evidenced by efficient, secure, reliable and available platforms) and agility (as evidenced by a readiness to formulate and implement timely and innovative competitive moves).

L. Gordon, M. Loeb and T. Sohail, “Market Value of Voluntary Disclosures Concerning Information Security,” MIS Quarterly, September 2010, pp. 567-594. 45

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Managing digitalization risks in a manner that balances stability and agility is a participation sport that demands the involvement of all of an organization’s members.

With the aim of providing a mindset and a foundation conducive for

effectively managing digitalization risk, this chapter covers the following topics: 

Nature of Digitalization Risks



Risk Management: A General Overview



Digitalization Risk Management Practices



The Board of Directors and Digitalization Risk Management



Accounting for Digitalization Risks in Digital Strategy Formulation

Nature of Digitalization Risks A digitalization risk refers to the likely occurrence of digitalization-related incidents that have the potential to negatively impact an organization’s operational performance and/or competitive position. What are these negative impacts? A useful way of thinking about these negative effects is the following loss categories: 

Financial loss: theft; fraud; extortion; destruction of uninsured facilities, equipment and materials; drops in stock valuations; regulatory fines; legal fees, court awards and out-of-court settlements; etc.



Revenue loss: short-falls in revenue streams or lost revenue streams traced to operational disruptions, reputation loss, the inability to respond effectively to competitors’ actions, etc.



Intellectual property loss: thefts of digitized ideas, innovations and other forms of creative expression (e.g., trade secrets, blueprints, digitalized processes, proprietary digital content, digital strategies, business models, etc.).



Reputation loss: depreciation of an organization’s image or of its brands that undermines the trust and goodwill held by participants in the various market-focused ecosystems with which the organization participates.

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These negative impacts can be huge.

Consider, for example, the losses suffered by

the TJX Companies after a security breach46 (reported in late 2006) that enabled hackers to obtain data from over 45 million customer payment cards.47 Access into the TJX Companies’ s business platform was gained by digitally eavesdropping on the POS transactions associated with the in-store customer return process. It has been estimated that the direct costs (the largest portion of which involved contacting and offering assistance to affected customers) to the TJX Companies for the breach might have been as high as $1.6 billion.48 Other of these direct costs involved obtaining legal advice, internal investigations, public relations and regulatory fines. However, these direct costs do not include the very sizeable revenue and stock valuation losses that occurred during 2007. Figure 8-1 provides a visual framework simplifying the complexities of the digitalization risk context. Here, three entities are brought together: a set of threats, a set of targets, and the actors most significantly associated with the occurrence of digitalization-risk incidents. Table 8-1 lists the loss categories typically associated with each of the types of threats and targets.

A security breach refers to an incident that results in the confirmed disclosure of data to an unauthorized third-party. 47 W. Xu, G. Grant, H. Nguyen and X. Dai, “Security Breach: The Case of TJX Companies, Inc.,” Communications of the Association of Information Systems, Vol. 23, November 2008, pp. 575-590. 48 C.R. Speechlys, “The Real Cost of a Data Breach,” Lexology, November 12, 2012: http://www.lexology.com/library/detail.aspx?g=2aaa771a-2523-4e60-a0bc-306db8323d0e 46

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Figure 8-1 Framing the Digitalization Risk Context Threats

Actors

Malicious Intrusion

Natural Disaster

Actions of a External Inability to Competitor Sourcing Respond

Legal & New Digital Regulatory Technology

Outsiders Cybercriminals Terrorists Hacktavists Ecosystem Participants

Digitalization Risks

Insiders Employees Senior Executives Business Platform Operations

Digital Assets

Internal Controls

Platform Digitalization Architectures Capabilities

Targets

Table 8-1 Losses Typically Associated with Digitalization-Risk Threats and Targets Loss Categories Threats Malicious Intrusion

Financial, Revenue, Intellectual Property, Reputation

Natural Disasters

Financial, Revenue, Intellectual Property, Reputation

Legal & Regulatory

Financial, Revenue, Reputation

New Digital Technology

Revenue, Reputation

Actions of a Competitor

Revenue, Reputation

External Sourcing Inability to Respond

Financial, Revenue, Intellectual Property, Reputation Revenue, Intellectual Property, Reputation

Targets Business Platform Operations Revenue, Reputation Digital Assets Internal Controls

Financial, Revenue, Intellectual Property, Reputation Financial, Reputation

Platform Architectures

Financial, Revenue, Reputation

Digitalization Capabilities

Financial, Revenue, Reputation

Let’s take a look at the actors (described in Table 8-2). Actors are associated with threat incidents in two ways.

Most often, actors are thought of as the

perpetrators of malicious intrusions – or, acts of commission. Cybercriminals (by 181

far the most common type of perpetrator), terrorists and hactavists clearly instigate

digitalization-risk

incidents,

as

can

ecosystem

participants

and

organizations’ employees (either acting alone or collaborating with others). Table 8-2 Actors Associated with Digitalization-Risk Incidents Actor

Description

Cybercriminal

Uses hacking techniques & tools in order to take illegal actions for financial gain or to take over digital assets in order to launch a series of illegal actions.

Outsider

Terrorist

Uses hacking techniques & tools for the purpose of causing harm & havoc within an established geo-political order.

Hactavist

Uses hacking techniques & tools for the purpose of bringing attention to a social or political issue.

Pipeline ecosystem participants (suppliers, upstream intermediaries, downstream intermediaries, consumers) and network ecosystem participants (members of interacting communities), who connect to organizations’ business/market platforms to facilitate ecosystem transactions.

Ecosystem Participant

Insider Operational, staff & managerial employees, who connect to the organization’s business platform to carry out their work roles.

Employee Senior Executive

Members of the leadership team, whom are collectively responsible for: seeding & overseeing digital strategy formulation & implementation, setting policies for digitalization, and allocating the resources necessary for effective digitalization.

Just as serious, though typically overlooked, are the acts of omission traced back to organizations’ employees and senior executives. It is not uncommon for employees

to

claim

ignorance

of

their

organizations’

digitalization-risk

policies/procedures or to be lax in following these policies/procedures. Because of employees’ acts of omission, organizations experience greater likelihoods of experiencing losses regarding three, in particular, digitization-risk incidents: malicious intrusion, natural disasters and legal/regulatory violations.

Even more

problematic, it is not uncommon for organizations’ most senior executives to abdicate some, if not most, of their managerial and fiduciary responsibilities regarding seeding and overseeing digital strategy formulation and implementation, setting policies for 182

digitalization, and for allocating the resources necessary for effective digitalization.49 Because of senior executives’ acts of omission, organizations have a greater likelihood of experiencing incidents regarding all nine digitization-risk threats. Figure 8-2 illustrates the relationships between threats and targets. Acts of commission, i.e., malicious intrusion, are most often directed at two threat targets: business platform operations and digital assets. Business platform operations refers to the execution of an organization’s digitalized operational and managerial processes that are hosted on business platforms (and on market platforms); and, digital assets refer to the digital technologies (hardware and software), digitized data, and digitization/digitalization capabilities applied in configuring digital platforms and business platforms. The most common incidents directed at business platform operations are denial-of-service attacks, where the aim is to disrupt business continuity either by flooding a platform with transactions, dramatically increasing transaction volumes (slowing response times) or by inserting a virus that damages the processing being performed on a platform (hence, shutting down the platform or producing processing faults that result in the platform being shut down for repair). The most common incidents directed at digital assets involve theft of digital content, with content then being used for criminal or business-espionage purposes.

A. Masli, V. Richardson, M.W. Watson and R.W. Zmud, “Senior Executives IT Management Responsibilities: Serious IT-Related Deficiencies and CEO/CFO Turnover, Management Information Systems Quarterly, September 2016, pp. 687-708. 49

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Figure 8-2 Associations Between Threats and Targets

Malicious Intrusion

Natural Disaster

Business Platform Operations

Legal & Regulatory

Digital Assets

New Digital Technology

Actions of Competitors

Internal Controls

External Sourcing

Platform Architectures

Inability to Respond

Digitalization Capabilities

Acts of omission play out across all five threat targets as needed digitalizationrelated investments and policies are either not pursued or pursued ineffectively and as sanctioned digitalization-related investments and policies are poorly implemented and/or followed. The consequences of not attending to business platform operations and to digital assets were addressed in the preceding paragraph. An organization’s internal controls refer to the processing logic and rules embedded within digitalized financial reporting systems to ensure the correct handling of financial transactions and the accuracy of produced financial reports. If an organization’s internal controls are in error or incomplete, the organization’s financial systems are susceptible to malicious intrusions and the organization – along with its CEO and CFO – are subject to penalties under the Sarbanes-Oxley Act. If organizations’ platform architectures are not designed and maintained so as to remain aligned with these organizations’ digital strategies, it is unlikely that appropriate stability/agility balances can be 184

achieved.

Finally, organizations lacking the digitalization capabilities to quickly

respond to competitors’ actions or to introduce innovative business models are unlikely to maintain, let alone enhance, their competitive positions. Prior to moving on to discussions of risk management and risk management tactics, let’s briefly examine each of the digitalization-risk threats. Malicious Intrusions A malicious intrusion refers to a perpetrator’s success in getting through an organization’s security-related defenses, i.e., the systems software and digitalized work procedures aimed at identifying and authenticating all physical and digitized attempts to access an organization’s digitalized business platforms and digital assets. Successful intrusion usually begins via either phishing or through a POS device, but then moves on to a wide gamut of abuses: theft, fraud, sabotage, denial-of-service attacks, viruses, worms, website defacement, electronic eavesdropping, etc.

As

these perpetrators and the hacking tools and techniques they use get better and better, the time it takes to compromise a victim just gets shorter and shorter. Today’s public and private digital infrastructures are becoming so large and so complex that they are beyond the control of any one organization. As a result, no matter how prudently an organization moves forward with security policies, procedures and programs, the organization remains exposed to the threat of malicious intrusion. The objective should not be to prevent all malicious intrusions, but rather to prevent less-sophisticated intrusion attempts and to minimize the damage caused by more-sophisticated intrusion attempts through quick detection, removal and repair.

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Natural Disasters Natural disasters (e.g., tornadoes, hurricanes, earthquakes, tsunamis, nuclear emergencies, collapsed dams, broken gas or water pipes, etc.), are worstcase scenarios for any organization.

If affected directly by a natural disaster,

business operations might be nonfunctional for days, weeks or months – resulting in significant, if not catastrophic, revenue losses. Even if affected only indirectly by a natural disaster, most organizations are likely to suffer some disruption to their inbound/outbound logistics flows. While it is impossible to predict the occurrence of such events, all organizations need to be prepared to act to minimize the effects of and quickly recover from any operational disruptions.

The implications of critical

business platforms becoming unavailable can be devastating, especially as evergreater portions of organizations’ business processes – the lifeblood of most organizations’ revenue streams – are digitalized. As natural disasters are unpreventable, the digitalization risk emphasis is on achieving a graceful degradation in platform operational performance and a quick recovery.

Graceful degradation means that operations affected by a natural

disaster do not immediately shut down, but instead gradually slow down, allowing time for affected operations to be shifted to other physical locations prior to a complete shutdown.

Both graceful degradation and quick recovery are typically

achieved by designing multiple redundancies into operational sites and activities. For example, the physical sites housing digitalization operations are outfitted with backup power systems, have all platform content (data and software) backed up on a regular basis (say, every two hours) at a distant recovery site, and might even have all processing activity instantly mimicked at the distant recovery site. 186

Legal and Regulatory Requirements Organizations today face a broad array of digitalization-related legal and regulatory requirements requiring protective actions most often aimed at preventing harm to others. Included among these regulations, that originate from federal, state and local governmental agencies, are those aimed at: 

Protecting personal data (about customers, employees, visitors, etc.) that is collected, held, processed and provided to others.



Ensuring the security and accuracy of financial transactions and reports.



Requiring data collection and information reporting by organizations whose products, services and work activities are environmentally-sensitive.



Requiring data collection and information reporting by organizations whose products, services and work activities are potentially harmful to consumers or employees.

Organizations (and, possibly, specific employees) found noncompliant with statutory requirements can suffer legal and civil penalties, as well as significant reputation losses. What makes the digitalization-related environments especially confusing and complex is that the nature of regulations (statutory versus voluntary, breadth and depth of coverage, sanctions for noncompliance, etc.) varies considerably across geopolitical boundaries (e.g., cities, states, nations, the EU, etc.). Table 8-3 describes a few

of

the

more

well-known

digitalization-related

regulations

facing

U.S.

organizations.

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Table 8-3 Examples of U.S. Digitalization-Related Regulations Regulation

Description

Family Educational Rights & Privacy Act of 1974

Educational agencies & institutions receiving funding from the U. S. Department of Education are required to provide students with access to their education records, an opportunity to seek to have the records amended, and some control over the disclosure of information from the records.

Health Insurance Portability & Accountability Act of 1996 Gramm-Leach-Bliley Act of 1999

Health care providers, insurance providers and employers are required to safeguard the security & privacy of patients’ health records and personal data. Financial institutions are required to protect the security & privacy of the financial information that they collect, hold and process.

Sarbanes-Oxley Act of 2002

Publicly traded companies are required to provide assurance of the security, accuracy & reliability of their financial reporting systems.

State Security Breach 50 States have enacted Security Breach Notification laws requiring Notification Law (First enacted businesses to make notifications regarding security breaches. by California in 2002) While no similar Federal law exists, bills have been introduced. Payment Card Industry Data Security Standard (Initially released in 2004)

Created by the Payment Card Industry Security Standards Council, this standard applies to all institutions that hold, process or exchange cardholder information. The standard strives to prevent credit card fraud through increased controls around data and its exposure to compromise.

New Digital Technologies The continued advancements with digital technologies result in seeming endless arrivals of innovative digital products and services, as well as innovative digitalized solutions from both established and new vendors.

While all new

technologies are largely untested when first released, those organizations able and willing to subject a seemingly-relevant new technology to early assessment and experimentation stand to gain the most from adopting that technology. Likewise, those organizations that delay their assessing of what turns out to be a gamechanging technology are likely to have dug themselves into a deep competitive hole. Actions of Competitors The

business

model

enhancements

and

innovations

of

established

organizations and startups pose a constant threat to any organization. While this has 188

always been the case, what is new today is the rapidity with which competitivelymeaningful actions appear and the fact that the organizations taking action increasingly lie beyond the boundaries of the primary market ecosystems within which an organization participates. What is perhaps most insidious are the rapid inroads that a new competitor can achieve regarding market share.

This can be especially damaging when an

innovative business model creates a protectable, highly-profitable niche within an existing

market,

subsequently

drawing

away

participants

from

established

competitors and attracting a majority of new market participants. External Sourcing Most typically, an externalized capability takes the form of a digitalized process developed by a provider (or another third-party) hosted on the provider’s business platform and accessed by the client via public or private Internet connections. When managed well, external sourcing provides an organization with significant cost, operational and strategic benefits. But, along with these benefits comes a heightened exposure to digitalization risk. Table 8-4 lists the digitalization risks, organized by target, most commonly attributed to external sourcing.

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Table 8-4 Digitalization Risks Associated with External Sourcing Target Business Platform Operations

Digitalization Risks  Operational gains (efficiency, security, scalability, etc.) not realized.  Provider platforms insufficiently enhanced, over time.  Provider platforms lack sufficient security.

Digital Assets  Data captured by or created by externally-hosted processes are typically owned by the provider (unless otherwise negotiated).

Internal Controls

 Processes executed on provider platform lack sufficient transaction & reporting integrity.  Provider platform architectures insufficiently enhanced, over

Platform time. Architectures  Provider platform architectures lose, over time, an acceptable stability/agility balance.

 Loss of internal-to-the-client digitalization capabilities. Digitalization  Provider fails to enhance digitalization capabilities. Capabilities  Provider fails to transfer new digitalization capabilities.

Inability to Respond The most debilitating digitization risk – though the risk that perhaps receives the least attention – is the inability to respond to competitors’ actions. Given the power of network effects (affecting consumer communities in pipeline ecosystems and all communities in network ecosystems), organizations must act effectively and quickly to meet or, ideally, to advance competitors’ competitive actions.

An

organization failing to act or acting in an ineffective or untimely manner is sure to suffer some erosion in market position – an erosion that will only spiral in the face of a continuing stream of competitors’ actions. What is the root cause of an inability to respond to a competitor’s action? A number of factors come to mind: 

A delay in becoming aware of the competitor’s action.



An incomplete understanding of the competitor’s business model.



An incomplete understanding of how the competitor executed the 190

competitive action. 

Inconsistencies between in-place platform architectures and the architectures needed to implement an effective response.



Deficiencies in one or more of the platforms needed to implement an effective response.



Deficiencies in one or more of the digital assets needed to implement an effective response.



Deficiencies in one or more of the capabilities needed to implement an effective response.



Delays encountered in resolving deficiencies in platforms, digital assets and capabilities.

And, as might be expected, failure to respond in an effective and timely manner increases when more than one of these factors apply to the situation-at-hand. Risk Management: A General Overview Risk management is a topic that applies across all aspects of organizational life, including digitalization.

The aim of this section is to provide a general

introduction to the topic area. It is important to recognize, first of all, that the intent of risk management is not to eliminate risks, but to manage risks.

Risk is an inherent aspect of

organizational life. While we can perfectly predict how an engineered system will perform, it is impossible to perfectly predict how humans (e.g., operational employees, managers, executives, consumers, suppliers’ employees, intermediaries’ employees, consultants, etc.) will perform. And, even if you could predict human behavior by limiting the available choices, would you want to?

Investments

promising high returns are generally riskier than investments promising low returns precisely because we cannot predict the outcomes of high-return investments very

191

well. By limiting the choices available to humans, you also limit the potential for individuals to act creatively and innovatively. Risk management strives to accomplish two objectives: creating awareness and a common understanding across an organization’s members about the existence and nature of a risk domain; and, putting in place risk management policies, procedures and programs to ensure that the critical risks in the domain are appropriately addressed by appropriate individuals.

In accomplishing these

objectives, risk management involves three activities: risk planning, risk assessment and ongoing risk control. Risk Planning Risk planning establishes the contexts within which risk management activities are carried out. Risk planning begins by identifying and categorizing the areas of risk most likely to affect an organization. Next, each risk area is assigned an owner. It is the risk owner’s responsibility to perform regular risk assessments, and to actively manage associated risks.

Then, overall risk management policies

need to be developed that provide a context within which risk owners can implement area-specific risk management policies, procedures and programs. Finally, high-level objectives are devised to articulate the importance of risk management. Examples of such high-level objectives might include:50 “Protecting the integrity and security of client and corporate information is the responsibility of every employee.”; and,

Adapted from: H.A. Smith and J. McKeen, “Developments in Practice XXXIII: A Holistic Approach to Managing IT-based Risk,” Communications of the AIS, December 2009, p. 525. 50

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“We need to embed an attention to digitalization risk management into all work processes, business functions, work roles and positions, and employees.” Risk Assessment During risk assessment, each risk owner, usually with the support of inhouse experts and external consultants, estimates the risk exposure associated with each of the risk areas for which the owner is responsible. Usually, some variant of the following formula is used: Risk Exposure = (Probability of Risk Occurring) X (Expected Loss If Risk Occurs) Organizations specializing in overall or domain-specific risk management have considerable knowledge, experience and data that can be tapped to produce estimates of risk probabilities and expected losses. Just remember that these generic estimates are only starting points that need to be tailored to the nuances of a given organization and that expected losses should include both tangible and intangible losses, as well as short-term and long-term losses.

The risk of underestimating

expected losses is that an organization is then likely to under-invest in risk-related policies, procedures and programs. Once a risk area has been assessed, the owner must decide (again, with input from others) how risks are to be addressed. Three actions are possible, alone or in combination: 

Risk assumption: Accepting that losses are likely to arise if and when an incident occurs in a risk area, covering these losses through internal funds and third-party insurance.



Risk deterrence: Taking action to reduce the likelihood that an incident will occur in a risk area.



Ongoing risk control: Monitoring a risk area such that the incident 193

occurrences are detected and resolved before excessive losses occur. The risk assessment matrix shown as Figure 8-3 provides general guidance on selecting an appropriate strategy for a risk area.

Risk areas with low incident

probabilities and low expected losses can reasonably be assumed without taking further action, while risk areas with high incident probabilities and high expected losses require sophisticated strategies involving combinations of risk assumption, risk deterrence and ongoing risk control. Figure 8-3 Risk Assessment Matrix

High

Monitor continuously to immediately mitigate detected risk incidents

Take preemptive action to reduce the incident likelihood

Take preemptive action to reduce the incident likelihood

Monitor continuously to immediately mitigate detected risk incidents

Monitor continuously to immediately mitigate detected risk incidents

Medium Monitor regularly to mitigate detected risk incidents

Monitor continuously to immediately mitigate detected risk incidents

Low Monitor regularly to Simply assume the risk mitigate detected risk incidents

Low

Medium

Take preemptive action to reduce the incident likelihood Monitor continuously to immediately mitigate detected risk events

Monitor continuously to immediately mitigate detected risk events

High

Expected Loss If a Risk Event Occurs

Ongoing Risk Control Ongoing risk control involves monitoring for risk incidents, detecting that an incident is about to occur (ideally) or has occurred (more likely), and taking action to mitigate any losses arising from the incident. Risk mitigation involves tempering (as much as possible) the consequences of a risk incident by taking corrective actions. Prior to implementing ongoing control procedures, the risk owner needs to determine 194

the level of cost and effort to put into the procedures. Figure 8-4 illustrates the complexity of this decision. The rational risk owner desires to neither under-invest or over-invest in ongoing risk control. Here, again, heavy use is made of others’ knowledge and experience. Figure 8-4 Determining the Cost of Ongoing Risk Control

Cost

Cost of Risk Deterrence/Mitigation

Sweet Spot Expected loss in the Absence of Risk Deterrence/Mitigation

Risk

An Exercise in Digitalization Risk Assessment51 An important element of the Coors Brewing Company’s marketing strategy involves having retailers place eye-catching point-of-sales (POS) displays in their stores.

In implementing this strategy, Coors works with third-party marketing

partners and third-party providers to produce these display materials.

However,

Coors owns the business processes that engage distributors and retailers in ordering these POS display items.

To motivate POS display orders, Coors provides each

This hypothetical exercise (used for illustrative purposes only) was developed by the authors based on material from: J. Buffington and D.J. McCubbery, “Coors Brewing Company Point of Sales Application Suite: Winning Mindshare with Customers, Retailers, and Distributors,” Communications of the AIS, Volume 13, 2004, pp. 81-96. 51

195

wholesaler and retailer with a budget that can only be used to order POS display items. Coors anticipates that at least some of the wholesalers and retailers will find the display materials valuable in their efforts to increase sales and, in turn, that they will order (display materials) beyond the Coors-provided funding. Coors’ solution for digitalizing the business processes enabling distributors and retailers to order promotional materials involved the building of a local (loosely connected to other business platforms) business platform hosting five sets of functionalities: 

Internet Interaction Portal: Enables distributors and retailers to communicate with Coors and to gain access to the digitized business processes.



Ordering General Materials: Enables distributors and retailers to order general promotional materials.



Ordering Licensed Materials: Enables distributors and retailers to order licensed (i.e., NFL logos) promotional materials.



Ordering Customized Materials: Enables distributors and retailers to design and order customized promotional materials.



Retail Store Display Placement: Enables distributors and retailers to visualize and optimize, through the use of digitalized tools, the physical placement of promotional materials within a retail store.

These functionalities were collectively aimed at achieving three main objectives: increasing sales of Coors products, having distributor and retailer staffs performing much of the work autonomously, and building stronger relationships with the distributors and retailers. Now, consider a risk assessment that might have been performed by the risk owner for this digitalized business platform. Table assessment.

8-5

summarizes

this

risk

Given this assessment, it would be reasonable to expect that a

digitalization risk management strategy put forward by the risk owner would involve: 196



Deterring and mitigating malicious intrusions, through the local business platform, into Coors’ global digital platforms and business platforms.



Ensuring that any future decision process to externalize any of the digital platforms enabling the local business platform carefully examine the providers’ capabilities to secure their platforms against malicious intrusions.



Establishing a vigilance regarding the potential for competitors to introduce retail shelf space innovations that could prove effective in taking market share away from Coors’ products.



Establishing a vigilance regarding the development of analytics technologies and solutions aimed at the retail shelf space context. Table 8-5 Risk Assessment for Coors’ POS Display Business Platform Threat

Situational Assessment

Incident Probability

Expected Losses

Malicious Intrusion

• Coors is a prominent firm selling a product (alcohol) that could be considered controversial. • Internet exposure & distributor/retailer connectivity. • Low loss exposure with the local business platform. • High loss exposure with global platforms.

High

Low (local) High (global)

Natural Disasters

• Favorable geographic location (Colorado front range).

Very Low

Moderate

Low

Low

Moderate

High

High

High

Moderate

Moderate

Moderate

High

Legal & • Limited access to financial systems. Regulatory • Limited privacy concerns. New Digital • Analytics technologies. Technology • Collaboration technologies. Actions of a • Retail floor & shelf spaces are highly competitive Competitor commodities. External Sourcing

• Business platform unlikely to be externalized. • Digital platform likely to be externalized.

Inability to • Analytic capabilities focused on optimizing the use of Respond retail store shelf space.

Digitalization Risk Management Practices Digitalization risk management practices (i.e., policies, procedures and programs) cover a very broad range of complex and ever-moving topics – topics for which it is impossible to do justice in a few pages of text. To provide a glimpse of what organizations are doing, this section describes a few of the current practices regarding one threat area: that of malicious intrusions. This threat area was selected for two reasons. First, since significant cyber-security breaches are reported on by 197

news media on a regular basis today, most people are well aware of the topic. Second, cyber-security breaches can result in huge financial losses, the size of which is increasing annually. Data from 2010, for example, indicated that the average cost of a security breach exceeded US $7 million.52 As a selection of the more common risk management practices for combating malicious intrusions are described, note that a mix of technical and social mechanisms are required. All too often, it seems, much more attention is given to the technical practices, with the just-as-critical social practices being overlooked and/or underfunded. Securing Digital and Business Platforms Against Malicious Intrusions It is impossible for any organization to fully protect itself against malicious intrusions.

That said, all organizations need to understand the intrusion risk

exposures of their digital and business platforms and take commiserate steps to both harden these platforms and detect (and mitigate) any intrusions that occur. Hardening a platform involves installation of hardware, software and physical impediments that increase the effort required by a perpetrator, such that all but the most determined perpetrators either bypass the platform (moving on to easier targets) or are so hindered that they quickly give up. Detection involves putting in place software and manual scanning processes that identify problematic behaviors transpiring within digital platforms and business platforms.

R. Appan and D. Becic, “Impact of Information Technology (IT) Security Information Sharing among Competing IT Firms on Firm’s Financial Performance: An Empirical Investigation,” Communications of the Association of Information Systems, Vol. 39, 2016, pp. 214-241. 52

198

Perhaps the most recognized hardening tactics involve the use of firewalls, encryption technologies, access control mechanisms, and physical barriers to develop multi-layered defensive shields around an organization’s digital and business platforms. Less prominent is identity management software that seeks to identify (“Who are you?”), authenticate (“Can you prove your identity?”) and authorize (“What are you allowed to do?”) platforms

and

authentication.

their

contents.

attempts, legitimate and illegitimate, to access The

most

difficult

of

these

questions

is

As the technology improves and costs drop, authentication

methods are moving away from examining what you know (e.g., a password) to examining something you have (e.g., biometrics such as the use of fingerprints, iris scans, voice scans, etc.). The most familiar detection tools are those directed at viruses (i.e., malicious software code), that have eluded the barriers erected in hardening a platform. Less visible are the huge investments organizations make in (1) capturing and then analyzing the streams of digitalized transactions being executed on digital and digitalized platforms, and (2) embedding processing logic into the software handling these transactions to identify and reroute problematic transactional events. Intra-Organizational Information Sharing Regarding Malicious Intrusions As emphasized earlier, digitalization risk management is a participation sport demanding the involvement of all employees. However, organizations’ employees demonstrate wide variance in: their awareness of, knowledge of and sensitivity to security breaches; their platform access privileges; their willingness to act in compliance with security breach policies and procedures; and, their abilities to act appropriately in the face of a security breach. 199

Because of these variances, many organizations are including comprehensive intra-organizational information dissemination and sharing programs as prominent components of their efforts to prevent and mitigate malicious intrusions.

These

programs typically include: 

Awareness Training: All employees are made aware of the basics of cybersecurity risk management (both work-related and home-computer use) and, specific to each employee, those risks most likely to arise as employees carry out their day-to-day work activities.



Platform Usage Training: Each employee interacting with a specific digital or business platform is provided with the knowledge and skills to effectively deal with the digitalization risks associated with that platform.



Specialized Training: All technology professionals and all risk owners are provided with advanced education to develop the capabilities needed for them to carry out their assigned responsibilities.



Technical Support: All employees are provided ready access to a cybersecurity support group that can answer questions that arise regarding the risk of malicious intrusions and that can aid an employee when faced with a probable or actual security breach.

Extra-Organizational Information Sharing about Malicious Intrusions Organizations’ leadership teams are increasingly recognizing the value of the external sharing of information about security breaches. Initially, most organizations were reluctant to report on security breach incidents because of the expectation that most stakeholders (e.g., consumers, value stream participants, strategic partners, securities analysts, etc.) would react negatively, at least in the short-term. However,

200

the consequences of reported security breaches, while still negative, have been declining over time.53,54 Three explanations for this decline are: 

More effective remediation and disaster recovery by firms, as well as a decrease in customers refraining from doing business with firms that experienced a security breach.



The U.S. Government’s promotion, since 1999, of industry-based trade associations known as information sharing and analysis centers (ISACs). As of 2016, there are eighteen sector-based ISACs coordinated under a National Council of ISACs.



The enactment of federal and state security breach notification laws. As more organizations actively gather and share information on digitalization-

risk threats, vulnerabilities and incidents, as well as best practices in digitalization risk management, their capabilities to combat malicious intrusions will only improve. Rather than feeling as if they are working alone against an increasingly hostile world, organizations’ risk specialists and risk owners will increasingly find themselves coordinating with and collaborating with their peers in other organizations, including competitors, in order to drive informed decision making. The Board of Directors and Digitalization Risk Management As a general rule, those organizations most successful in applying digitalization for competitive purposes have developed exceptional capabilities in digitalization risk management. But, who, ultimately, is accountable for the quality of an organization’s

L. Gordon, M. Loeb and L. Zhou (2011), “The Impact of Information Security Breaches: Has There Been a Downward Shift in Costs?”, Journal of Computer Security, Vol. 19, No. 1, 2011, pp. 33–56. 54 S. Goel and H.A. Shawky, "The Impact of Federal and State Notification Laws on Security Breach Announcements," Communications of the Association for Information Systems: Vol. 34, January 2014, pp. 37-50. 53

201

digitalization risk management capabilities? With a public firm, it is the firm’s Board of Directors. However, most Boards of Directors have only gradually – and grudgingly – stepped

up

to

their

oversight

responsibilities

regarding

digitalization

risk

management. For example, studies55,56,57 of Boards of Directors portray the following practices: 

Board members are not actively recruited for their digitalization expertise. Few executives of organizations recognized as digitalization leaders are members of Boards of Directors.



Very limited discussions of digitalization take place at Board meetings.



When digitalization is discussed at Board meetings, these discussions tend to be after-the-fact updates regarding recent, significant digitalization initiatives.



Most of this limited discussion of digitalization occurs in Board committee meetings. Most often, this committee tends to be the audit committee, where the issues raised are done so in reaction to a problematic event.



Few Boards of Directors have a committee focused exclusively on digitalization.

Overall, a state of complacency regarding digitalization continues, with Board members believing that their organization’s leadership team has a solid handle on managing the risks of digitalization. That said, a growing number of exceptions to this general depiction can be observed in recent trends regarding Boards of Directors and digitalization.

S. Huff, P. Maher and M. Munro, “Information Technology and the Boards of Directors: Is there an IT Attention Deficit,” MISQ Executive, June 2006, pp. 55-68 56 M. Parent and B. Reich, “Governing Information Technology Risk,” California Management Review, Spring 2009, pp. 134-152. 57 S. Andriole, “Boards of Directors and Technology Governance: The Surprising State of the Practice,” Communications of the CAIS, Volume 24, Article 22, 2009, pp. 373-394. 55

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What should be the role of Boards of Directors in managing digitalization risk? Three Board responsibilities are most important. The Board of Directors must assure that their organization is not overly exposed to digitalization risks that threaten business continuity, regulatory compliance and competitive success. In order for these responsibilities to be met, Boards of Directors need to adopt best practices such as:58,59 

Bringing members with digitalization experience and expertise onto the Board.



Regularly inviting senior executives whose work responsibilities involve strategically-critical digitalization initiatives to Board meetings.



Systematically including digitalization issues on the agenda of full Board meetings. For the most part, the focus of these discussions needs to address strategic rather than tactical issues, including Board reviews of all major digitalization-related assets, investments and initiatives.



Establishing a Board digitalization committee.

Accounting for Digitalization Risks in Digital Strategy Formulation Digitalization risks affect digital strategists’ thinking in two ways: by adding layers of complexity onto their efforts to enhance existing business models and to innovate with new business models, and by requiring that the requisite capabilities are in place to enable both business model formulation and business model implementation.

Table 8-6 describes how each of the four elements of business

models are influenced.

M. Bloch, B. Brown and J. Sikes, “Elevating Technology on the Boardroom Agenda, McKinsey Quarterly, 2013, No. 1, pp. 99-103. 59 H. Sarrazin and P. Willmott, “Adapting Your Board to the Digital Age,” McKinsey Quarterly, 2016, No. 3, pp. 89-95. 58

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Table 8-6 How Business Models Are Affected by Digitalization Risks Value Propositions

Profit Models

 Provide value in return for personal data that is captured, archived and/or used.  Ensure the security, and hence the trustworthiness, of digital platforms and business platforms.

 Comprehensively and accurately account for the digitalization risk management costs associated with developing, implementing and evolving a business model.

Core Capabilities

Dynamic Capabilities

Tuning of digital strategists’ environmental scanning regarding:  Digitalization risk management  Digitalization threats. capabilities (accounting for all threat  Digital technologies. areas).  Strategic capabilities.  External sourcing providers.  Competitors’ business model innovations.

Increasingly, critical features of the value propositions being offered to pipeline ecosystem consumers and network ecosystem participants are dependent on personal data provided by or collected about individuals. If an individual feels the quid pro quo is inadequate, the individual is unlikely to engage, partially or fully, in market ecosystem interactions.

Similarly, market ecosystem participants lacking

trust in the platforms enabling a value proposition would be expected to refrain from platform interactions. The long-term expectation from aggregating the profit models associated with a business model is that the business model will prove profitable.

However, if a

business model’s risk exposure requires extensive digitalization risk management capabilities, and if the investment and operating costs associated with these capabilities are not fully accounted for in the business model’s aggregated profit models, then what might appear initially to be a very successful business model is likely to become a huge liability over time.

204

If nothing else, this chapter’s content should have driven home the point that in a world of pervasive digitalization, digitalization risk management has become a core capability for all organizations and a strategic capability for some (e.g., financial services organizations, e-commerce organizations, cloud-based organizations, etc.). If digitalization knowledge and experience is not represented within organizations’ senior leadership teams, as well as within the Board of Directors of private firms, then it becomes unlikely that a strong digitalization risk management capability will be developed. Finally, and most importantly, as extensive digitalization pervades an organization’s strategies and operations, the breadth of the organization’s dynamic capabilities must span an increasingly-wide gamut of markets, competitors, strategic partners, strategic capabilities and digital technologies. A Recap and Look Ahead Competitive success in the face of digital disruption requires organizations’ leadership teams and digital strategists to demonstrate relentless vigilance with regard to digitalization opportunities and, as covered in this chapter, digitalization threats.

But, how can such a mindset be established within an organization’s

members?

In the next chapter, six actions aimed at just such an objective are

described.

205

Chapter 9. Executive Mandates: Digital Strategy

Today, leadership teams are likely to find themselves spending an

inordinate amount of time examining the opportunities and thr eats pervasive digitalization poses to their organization, their industry, their employees and themselves. The digitalization of pipeline ecosystems and network ecosystems, of the products and services being exchanged within these ecosystems, and the core capabilities driving competitive success continues at an incessant pace.

Most

worrisome, perhaps, is a realization that it is increasingly difficult to predict the source and direction of the next potentially-damaging move by a competitor. Then, once a competitive attack has occurred, deciding how to respond becomes just as perplexing. The options seem endless: 

Doing nothing at all, hoping that the attack will dissipate quickly with minimal effect.



Distracting your existing customers from the competitor’s move through surface-level enhancements to the value propositions offered to these customers.



Boosting the effectiveness of your executing business model through a series of digitalization initiatives.



Quickly imitating the attack (as best as is possible given held-capabilities), hoping to ride the wave, limit the damage and capture some of the new value being created.



Introducing a well-thought-out but small-scale disruption of your executing business model in order to capture a niche in or to redefine your current market space or to create a new market space.



Aggressively reallocate resources from the digitally-threatened market space to a digitally-promising one that matches well with your core capabilities.

206

If anything, arriving at an effective competitive response can prove to be a greater challenge than recognizing and understanding the implications of a threatening move by a competitor. So, how should organizations’ leadership teams position themselves and their organizations for incessant digital disruption? The first step is to acknowledge that, while digital technologies are the basis of digital disruption, digital technologies are not the basis of effective digital strategy. Instead, what is critical is the adoption of a digitalization mindset across the leadership team (and, ideally, all of an organization’s members), the building of a digitalization culture across the organization, and the infusion of key notions into the thought-processes of digital strategists. The following six mandates are offered to senior executives desiring to maintain their organizations’ competitiveness in the face of digital disruption: 

Embrace a Digitalized Ecosystem Mindset



Innovate and Iterate for Digitalization Success



Invest in Data and Analytics



Evolve Processes and Platforms at Multiple Speeds



Track and Valuate Intangible Digital Assets



Cultivate a Digitalization Culture

Embrace a Digitalized Ecosystem Mindset The dominant mindset held by many, if not most, senior executives today is that their organizations operate in a well-defined competitive space, engage in mostly-linear upstream and downstream processes, and execute a relatively-stable business model. But, digitalization shakes up the competitive space in many ways: incumbent competitors are reinventing themselves; new entrants (startups, digital 207

giants,

technology

entrepreneurs,

etc.)

regularly

emerge;

and,

suppliers,

intermediaries and consumers are demonstrating increasing flexibility in deciding with which organizations to interact and with which markets to participate, as each seeks out the value propositions that best meet their ever-evolving desires and requirements. Successful leadership teams today are increasingly adopting a digitalized ecosystem mindset – that is, a view of competitive spaces as markets characterized by high rates of business model evolution/innovation, high levels of information sharing and value co-creation by market participants, and high rates of participant entry/exit. In such competitive environments, competitive success largely hinges on leadership teams: looking outward first, and then inward; and, developing capabilities to identify, assess, engage, collaborate with and disassociate from strategic partners. The primary intent driving the digitalized ecosystem mindset is to become the partner of choice in each market space in which an organization participates. What makes an organization an attractive partner in the face of digital disruption?

A

deceptively short list of desired qualities includes: 

Capable, creative digital strategists (often referred to as chief digital officers) across an organization’s operating and staff units, able to orchestrate (internally and externally) innovative, value-adding digitalization initiatives.



A talented, digitally-savvy workforce.



Efficient, secure, adaptable and interconnected platforms that can be connected to or decoupled from quickly and with little investment.

Two organizations whose leadership teams are noted for having demonstrated digitalized ecosystem mindsets are General Electric (GE) and LEGO. 208

Recognizing that it needed to transform itself into a modern digital business, GE has invested over $1 billion to position itself to become a competitive leader of the emerging, highly-digitalized market ecosystems within which it was already and would be participating.60 To infuse a digitalized ecosystem mindset into the firm’s executive leadership, GE consolidated each business unit under a chief digital officer (CDO), with these CDOs reporting to the business unit CEOs. Importantly, these CDOs have approval authority for digitalization-related investments. GE has also gone on an ambitious hiring spree, bringing in thousands of new software engineers, user-experience experts, and data scientists to acquire needed skillsets and embed the right innovation mind-set. After having verged on defaulting on its debt in the early 2000s, LEGO has again become a thriving business once its leadership team adopted a digitalized ecosystem mindset in which there was no longer a separate digital strategy that was aligned with business strategy, but rather a corporate business strategy executed through digitalization.61 The three core elements of LEGO’s overarching digitalized business strategy involved: product innovation and the product ecosystem; digital marketing; and, a transition toward global, rather than local, platforms.

Key

initiatives put in place to enable this overarching strategy included: distributing much of the corporate information technology function into business units; appointing CDOs

T. Catlin, L. Harrison, C.L. Plotkin and J.r Stanley, “How B2B Digital Leaders Drive Five Times More Revenue Growth than Their Peers,” McKinsey Quarterly, October 2016, http://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/how-b2bdigital-leaders-drive-five-times-more-revenue-growth-than-their-peers 61 O.A. El Sawy, P. Kraemmergaard, H. Amsinck and A.L. Vinther., “How LEGO Built the Foundations and Enterprise Capabilities for Digital Leadership,” MIS Quarterly Executive, June 2016, pp. 53-64. 60

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within business units for the purpose of orchestrating digitalized innovation; nurturing an experiment, learn and iterate capability across the firm, leveraging the complementary

digitalization

capabilities

of

LEGO’s

ecosystem

partners;

implementing flexible and open engagement platforms, while reducing complexity and maintaining security in enterprise platforms; and, hiring flexible, dynamic and adaptable employees able to cope with task and position changes and to work on digitalization projects anywhere in the firm.

Innovate and Iterate LEGO’s tactic of innovation via iteration is not uncommon among digitalization leaders. Being a first-mover (or, an early adopter) with a new digital technology or a new digitally-enabled functionality is fraught with risk. Will the technology work as expected, and at what cost?

Will enhancements to customers’ or employees’

interactive experiences be favorably received and, hence, contribute to improving the value propositions of executing business models or lead to the creation of new business models?

Will the operational improvements made possible by new

functionality improve the profit models of executing business models or enable an executing model to be applied to an adjacent market space? Iteration – that is, engaging in a series of mindful strategic experiments – allows the proponents of an innovation to gain some of the innovation’s anticipated benefits while still learning about and improving the innovation. Amazon, for example, uses an internal experimental platform to evaluate improvements to its websites and products through a factual, experimental approach

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to constant innovation.62 If anything, the number of these experiments is increasing over time – as can be observed from an April 2014 letter to Amazon shareholders that reported the number of these experiments growing from 546 in 2011 to 1,092 in 2012 to 1,976 in 2013. Successful digitalization requires that organizations transform how they think about innovation in two key ways.

First, digitally-savvy talent must be deeply

involved with innovative initiatives at every stage: creating the idea, improving the concept, building early prototypes, assessing the viability of these prototypes, designing and launching a series of strategic experiments, and, finally, incorporating the innovation as a standard way of doing business. Second, at their start, successful digitally-enabled innovations are almost always kept separate from the standard way of doing business. By separating innovative initiatives from normal operations, two things occur: it becomes easier to attract creative, digitally-savvy talent to work on the initiatives, and the innovative initiatives are less likely to be impeded by entrenched ways-of-thinking, policies and procedures. At some point, leadership teams need to make a critical decision: “Is a successful digital innovation maintained as a separate entity or is it folded into the standard way of doing business?” The ultimate goal for any established organization is to develop capabilities that competitors are unable or unwilling to imitate. Consequently, most leadership teams will want to eventually integrate the digital innovation with the rest of the organization. Doing so creates a seamless digitalphysical experience, enables greater efficiency via economies of scale and scope,

P. Bell, “Sustaining an Analytics Advantage,” Sloan Management Review, Spring 2015, pp. 21-23. 62

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permits better coordination, avoids duplicated effort, and facilitates timely communications and decisions. But, what if an organization’s established business models are severely threatened by a digital innovation? In such situations, it just might be best to keep separate the innovative business models and the established business models, letting these compete for market share until only one is left. Invest in Data and Analytics Increasingly, the most telling pathway to value creation through digitalization involves applying analytic models to the vast quantities of data permeating digitalized market ecosystems.

To take advantage of this pathway, an organization must

possess the capabilities to recognize the value potential of data streams that are both fleeting and voluminous, and to capture, organize, analyze and apply these data in value-creating ways. Thus, investing smartly and proactively in the technologies, tools and talent needed to position an organization such that it is able to quickly and effectively exploit data-related, value-creating opportunities as they arise can pay huge dividends over time. What exactly are these value-creating opportunities?

Invariably, the

immediate answer to this question involves being able to combine data and analytic models by using: 

Transactional data along with efficiency and effectiveness metrics to improve operational process (upstream, internal, downstream) performance and managerial process (decisions, coordination, oversight) performance.



Customer/client, community, product, service and promotional data along with market, industry and macroeconomic data to better understand customer/client/community motivations and behaviors, product/service portfolios, and market and business model viabilities.

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Less obvious, however, are data monetization opportunities. Data monetization refers to the bundling together of well-defined sets of data and analytic models such that the intangible value of data is transformed into something of tangible value. Two primary approaches to data monetization exist. With the first approach, streams of data involved in an organization’s operations are captured, cleaned and repackaged (via analytics) such that the data become valuable to other organizations. Think of the vast amounts of data a big box retailer collects on POS devices, which can be complemented by associated customer/geographic data. Or, think about the vast amounts of data collected by auto insurance companies on the devices installed by car owners to monitor driving behavior. Or, consider that one oil rig with 30,000 sensors may examine only one percent of the data collected because it uses these data to detect and control anomalies63 – ignoring the value of the data in supporting drilling optimization and oil/gas prediction activities, when combined with similar data from hundreds of other rigs. Such data products can be sold directly to organizations desiring to use the data or to third-party data marketplaces. With the second approach, an organization offering specialized services to clients can use historical client-engagement data to develop optimized algorithms that can then be applied to data collected on a new client engagement, enabling superior services to be provided to this new client at a price-point below that of many, if not most, competitors.

J. Deichmann, K. Heineke, T. Reinbacher and D. Wee, “Creating a Successful Internet of Things Data Marketplace, McKinsey Quarterly, October 2016, http://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/creating-asuccessful-internet-of-things-data-marketplace 63

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Consider, for example, ExcelShore, a digitalized tool developed by Cybage, an Indian technology services provider.64

Initially conceived as tool for analyzing

Cybage’s internal resources, ExcelShore analyzes collected client data (e.g., the client’s business history, current operations, prospective projects and resources; data about the client’s industry; etc.) to generate solution recommendations for the client, as well as a customized dashboard used by ExcelShore staff to manage the client engagement. With ExcelShore, Cybage is able to offer fee structures (to its clients) that are generally 20-25 percent lower than the fee structures offered by its largerscaled competitors – without compromising service quality or consistency. For another example, consider the strategy followed by Littler, a global employment and labor law practice, in unbundling many of the tasks involved in delivering services to clients by assigning these tasks either to knowledgeable people (possibly contractors) with pay scales below those of specialized attorneys or to digitalized products with automation and analytics capabilities, depending on the level of sophistication involved.65 Now, instead of billing clients for the hours its attorneys spend on claims, Littler uses a fixed-fee pricing model based on productivity (per grievance or complaint) for certain of its legal services. This change has resulted in lower legal costs for clients (figures ranging from 10-35 percent), enabling Littler to win new business.

A. Kathuria and B. Yen, “The Art of Winning an Unfair Game: Cybage & India’s IT Industry,” Communications of the Association for Information Systems, Vol. 37, 2016, pp. 753-766. 65 M. Sawhney, “Putting Products into Services,” Harvard Business Review, September 2016, pp. 83-89. 64

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Evolve Processes and Platforms at Multiple Speeds Organizations embarking on a digitalization journey almost always face a recurring challenge – projects targeted at enhancing digitalized products, services, engagement platforms and customer/community-facing processes tend to be more numerous and to move at a much faster pace than projects aimed at enhancing the mission-critical and house-keeping transactional processes and platforms that keep an organization running and compliant with regulators. This in itself is not a problem. What is a problem is that sooner or later – actually, mostly sooner – the process or platform that evolves at a fast pace must be interconnected to and synchronized with processes or platforms that evolve at a slower pace; and, it is with these efforts aimed at interconnection and synchronization that serious problems can arise: 

Fast-paced projects are slowed down or derailed.



Processes or platforms that must be quick, efficient, reliable and secure begin to exhibit performance problems.



Governance systems put in place to ensure process/platform stability impede process/platform agility (or vice versa).

What can an organizations’ leadership teams do to minimize such problems? Actually, the challenge is more severe than might be inferred from the above discussion. All organizations today depend on digitalized processes executed from a mélange of digital platforms and business platforms. Depending on the nature of the processes hosted on a platform, a platform’s design could: 

Emphasize stability, agility or both.



Emphasize operational excellence, customer intimacy and/or product leadership.



Evolve at a rate to maintain alignment with the rate at which crucial ecosystem elements change; this could be a fast rate, a slow rate, or 215

anywhere in between. Think of a juggler having to keep a set of balls moving despite the fact that each ball is also moving in a unique orbit around a central orbital point. So, ideally, these processes and platforms are not evolving at two rates of speed or at three rates of speed, but at many rates of speed. Process owners and platform owners across the organization must evolve their processes/platforms at very different rates of speed and, over time, are likely to have to adjust these rates of speed. So, again, what can an organization’s leadership team do? An easy, quick, one-size-fits-all solution just does not exist. Instead, a leadership team needs to fashion, over time, a new and consistent set of organization, platform and governance models: 

Organization Design: establishing process and platform management reporting structures to enable seamless process/platform design, development, operation and evolution.



Platform Design: transitioning to modular platform architectures, a consistency in module interfaces, and an understanding of when and where to use tight or loose inter-platform and intra-platform connections.



Governance Design: redesigning an organization’s expansive collection of planning, control and budgeting systems to facilitate, rather than inhibit, an appropriate rate of evolution for each process and platform.

While organizations’ leadership teams may not possess the expertise involved in carrying out these activities, it is critical that leadership teams provide direction and oversight.

Issues related to reporting structures, to platform architecture and to

negotiations regarding priorities, investment funds and operating budgets are precisely those that can produce severe intra- and inter-unit conflicts – conflicts that often can only be resolved by an organization’s most senior executives.

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Track and Evaluate Intangible Digital Assets Two forms of capital underlay organizations’ digitalization success. The first involves tangible digital assets, or the commodity technologies (e.g., servers, routers, messaging services, Internet standards and software, etc.) that serve as the building blocks of digital platforms and of business platforms.

Invariably,

organizations’ investments in tangible digital capital appear as capital investment on company books. The second type of capital involves intangible digital assets, such as: 

Market, product, services and platform designs that attract, engage and retain large numbers of ecosystem participants.



Operational and analytical processes that capture, organize and exploit data regarding market events, about operational and managerial activities, and about participant beliefs, expectations, behaviors and perspectives.



Knowledge and skills held by an organization’s employees as well as its partners’ employees.



Digitalization reputation acquired by an organization.

Well-known examples of intangible digital assets are Amazon’s and Netflix’s recommendation engines, both of which have contributed significantly to each company’s

revenue

growth

and

served

as

long-lived

competitive

barriers.

Conventional accounting invariably treats intangible digital capital as an expense, rather than as a capital investment, thus creating an investment disincentive (at least in the short-term). With little guidance from conventional accounting methods regarding how to track and attach financial value to intangible digital assets, many organizations’ financial groups perform this task poorly or not at all.

As a consequence, an

organizations’ leadership teams have little solid evidence on which to assess their 217

organizations’ investment in digitalization over time or to compare these investments against that of competitors. Both a retailer lacking rich data on consumers or a bank unable to control the capture of customer data (because customers access banking services through a third-party digital platform) face increasingly daunting competitive disadvantages. Organizations’ leadership teams must ensure that their organizations have taken on the difficult tasks of: 

Reclassifying expenditures to separate out intangible digital assets.



Tracking the spending on intangible digital assets (typically overlooked by accounting procedures).



Assigning appropriate value to investment in intangible digital assets.



Treating these investments, minimally with regard to digital strategy formulation, as capital investments rather than current expenses.

Cultivate a Digitalization Culture Acquiring and developing technology-based capabilities – such as those based on Big Data, Big Data analytics and cloud services – are obviously crucial to digitalization success. executive

action:

However, consider the issues presented as mandates for

mindsets,

innovation,

experimentation,

data

monetization,

operating at multiple and variable speeds, and a preoccupation with intangible assets. Each of these, at their core, reflect aspects of a digitalization organization culture. Organization culture is one of those terms that are intuitively understood but that prove difficult to define simply. Suffice it to say that an organization culture is comprised of the assumptions, values and norms of behavior collectively held by an organization’s members. Spend time observing how an organization’s members act and interact, and you will inevitably come away with an understanding of the organization’s culture. The more time spent observing, the richer the understanding. 218

This same thing happens as new employees sense and adopt the particular culture of their organization and act accordingly. In stable environments, executives tend to rely on what has been learned from past experiences to build the system of policies, directives, rules, routines and topdown reporting relationships that mold employees’ perspectives and actions. In volatile environments, however, organization structures that protect and exploit current mindsets and capabilities often induce strategic inertia, where attention and investment is given to things that no longer matter.

As has been recurrently

emphasized, environments beset with the constant threat of digital disruption are anything but stable. As the drivers of this instability are strongest at the edges of organizations and at the edges of market-focused ecosystems, the importance of local knowledge and strategic agility intensifies. As a result, executives striving to position their organization for digitalization success are advised to transition their organizations and themselves toward a very different organization culture, a digitalization culture that largely relies on the capabilities and judgments of employees – working alone and in small groups – holding local knowledge and unencumbered by bureaucratic or overly-burdensome hierarchical constraints. What does this emerging digitalization culture look like? A good starting point is to recognize how digitalization is enabling us, as we carry out our consumer and employee roles, to achieve better outcomes from taken-actions:66 we are being given more options, more information about these options, and more permission to act as we think best. To grasp what is implied by – and gained from – a culture that

B. Libert, M. Beck and J. Wind, The Network Imperative: How to Survive and Grow in the Age of Digital Business Models, Boston, MA: Harvard Business Review Press, 2016. 66

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first and foremost relies on employees’ capabilities and judgement, consider the following two illustrations.67 

An Asian insurance company hosted an intensive digitalized jam session over a 48-hour period, assigning 120 participants to ten cross-functional teams and tasking these teams, via a friendly competition, to redesign how customers processed their healthcare claims. The final outcome produced went far beyond the initiative’s original scope – effectively eliminating the need for processing customers’ claims.



A telecom company wanted to both shorten its product-development time (six months, on average, from start to active-trial) and include employee training and internal pilots within this shortened time period. A mixed team of product managers, digital technology professionals and engagementexperience experts tore apart the company’s old process and laid out a simpler, automated approach that allowed customers of its fiber, mobile, and TV services to access service in three quick steps. They conceived, tested, and built the new process in less than twelve weeks.

Rather than attempting to define the elements that come together to form a digitalization culture, we illustrate a digitalization culture in practice through the efforts taken by Valve Corporation’s leadership team to transform the firm’s organization culture.68 Beginning as a video game company, Valve has evolved into a digital distribution platform, known for products such as Steam and SourceForge. Valve’s self-reported revenues per employee and profit per employee metrics exceed those of Facebook and Google, signaling quite vividly that Valve is succeeding in a fast-

T. Catlin, L. Harrison, C.L. Plotkin and J. Stanley, “How B2B Digital Leaders Drive Five Times More Revenue Growth Than Their Peers, McKinsey Quarterly, October 2016. http://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/how-b2bdigital-leaders-drive-five-times-more-revenue-growth-than-their-peers 68 The discussion of the Valve Corporation has been adapted from materials in: T. Felin and T.C Powell, “Designing Organizations for Dynamic Capabilities,” California Management Review, Summer 2016, pp.78-96. 67

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moving environment requiring constant agility, strategic innovation, and market adaptation. A key factor behind this success is Valve’s culture, which emphasizes the firm’s dependence on employees’ capabilities and judgements (as reflected in the Valve new employee handbook). Employees are expected to: 

Steer, without asking for approval, the firm toward opportunities and away from risks.



Constantly be looking for more valuable ways to spend their time.



Allocate up to 100% of their time to self-directed projects.

Why such a dependence on the initiative of individual employees? In environments demanding that competitive opportunities and threats are quickly sensed and responded to, the immediate challenge for organizations’ leadership teams is to effectively leverage the information, knowledge and capabilities held by the organizations’ members and applying these in collective decision-making. Thus, a paramount task of the leadership teams of organizations seeking digitalization success is to ensure: 

Employees are in constant contact with relevant elements of the competitive environment and with other individuals (both inside and outside the organization) holding relevant information, knowledge and capabilities.



Employees are provided the motivation, time and resources to learn from, share with, and collaborate with these other individuals.

Valve’s leadership team has gone beyond traditional decentralization toward radical decentralization by giving talented specialists in product research, design and engineering full autonomy to propose projects, recruit project teams, establish budgets, set timelines, and ship products to customers.

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Nonetheless, it is important to recognize that radical decentralization has advantages and disadvantages. As a guiding principle, radical decentralization gives authority to those who operate closest to the action – that is, to individuals, groups and units holding specialized knowledge and operating at an organization’s edges, thereby facilitating local creativity and experimentation while minimizing bureaucratic roadblocks. What radical decentralization lacks is the assurance that taken-decisions and taken-actions are vetted by affected-others (individuals, groups and units) and, if needed, adjusted. Allowing for such assurance, however, takes time. In an era of digital disruption, it does not take much of a delay to significantly reduce the benefits actually realized from a competitive action. To address this quandary, Valve employs mechanisms referred to as social proofs – a social influence mechanism aimed at producing coordinated behavior among individuals. As Valve’s leadership team sees it, a purposeful system of social proofs provides an effective counterweight to the chaotic tendencies of radical decentralization. The primary behavioral mechanism driving Valve’s social proofs is selfselection; that is, employees vote with their feet.

They assess markets for new

opportunities, gather information about existing projects and teams, and decide by themselves whether to join an existing team or to form a new project. Obviously, not all the decisions made by employees are optimal, for the employee or for Valve. However, experience at Valve suggests that, in the aggregate, the choices made by talented, empowered individuals provide insightful, reliable and low-cost predictions of where and how fast the market is moving.

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While self-selection empowers the right people to make decisions, it does not by itself overcome the disadvantages of radical decentralization.

Not wanting to

impair employees’ initiative by putting in place multiple approval layers, Valve’s leadership team conceived a method of social convergence referred to as the rule of three. Learning from experience, Valve’s leadership team recognized that it was a rare occurrence for one or two individuals, regardless of reputation or capability, to command enough information or resources to sense, shape and seize a sizeable market opportunity. Under the rule of three, new projects are only considered for approval when at least three individuals come together to propose a project. The rule of three, thus, provides a light-touch intervention that allows Valve to stimulate innovation

and

to

limit

the

chaos

that

can

otherwise

debilitate

radical

decentralization. A Recap It is important to recognize that the six mandates just described are neither silver bullets nor readily implemented. The policies and practices put in place in one organization may or may not work when applied within another organization. Instead, in approaching each of the mandates, an organization’s leadership team needs to interpret the mandate through a lens that reflects the organization’s inplace culture, human talent, digitalization history and competitive environment. Such an assessment should suggest how the spirit of the mandate is best applied as well as the steps to be taken to implement the refashioned mandate. As an organization’s leadership team begins to achieve progress in diffusing these six mandates across their organization, a number of things should begin to occur, including: 223



Existing policies and practices will increasingly be questioned.



Employees will increase the amount of time they spend interacting with others outside their areas of immediate responsibility.



Decisions will increasingly be expected to be justified through facts, e.g., analyzed data.



The volume of innovative ideas bubbling up across the organization should increase.

While a surge in such behaviors might be unnerving to some of an organization’s managers and executives (at least in the near term), it is precisely these type of behaviors that will enable an organization’s digital strategists to engage in the dialogues and debates that ultimately generate timely and successful digital strategies.

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GLOSSARY

CHAPTER 1: Digital Innovation and Disruption Analytical domain – one of the three domains of digitalization; organizational activities involved in improving understandings of what things should be done, what things need to be done, what things can be done, how things are done, and how what has been done is assessed. Architecture – an overarching design framework specified to maintain established policies and to enable component interoperability. Automation – one of the four engines of digitalization; simplifying and digitizing complex tasks and task-sequences, eliminating unneeded tasks and, as appropriate, performing tasks via digital technologies rather than via humans. Blended organization – an organization that operates, to varying extents, as both a pipeline organization and a network organization. Business-to-business (B2B) – when market exchanges occur between two organizations. Business-to-consumer (B2C) – when market exchanges occur between an organization and a person. Business disruptions – when an industry’s incumbents face one or more challengers whose business models offer far greater value to customers than the incumbents’ business models and these incumbents are unable to effectively respond to the ensuing competitive threat. Business model – a simplified and aggregated conceptualization of the valuecreating, profitability-sustaining activities of an organization. Collaborative domain – one of the three domains of digitalization; organizational activities involved in enabling digital technologies, humans and organizational entities to share data, information and/or knowledge in making decisions and in getting things done. Consumer-to-consumer (C2C) – when market exchanges occur between two people. Control – one of the four engines of digitalization; embedding rules within digital solutions to identify out-of-control events/situations, such that out-of-control events/situations do not occur or, if they do occur, are quickly corrected. Data – attributes of objects or events represented in digital (discrete sets of ones and zeroes) form. 537

Digital disruption – when the innovative uses of digital technologies and globalization are the primary factors leading to incumbents within existing industries facing overwhelming competitive challenges and to entirely new industries being created. Digital giants – firms that have mastered digitalization and are able to harness their business models and digitalization expertise to disrupt a wide range of industries. Digital technologies – the technologies (involving hardware, software and, most often, sophisticated combinations of hardware and software) involved in specifying, capturing, processing, storing and transmitting data. Digitalization – applying digitization within organizations and within the social and economic contexts within which organizations are embedded. Digitization – the purely technical processes associated with converting sensed and captured data into binary form, storing and transmitting these binary data, manipulating these data, and storing/transmitting the outcomes of these data manipulations. Domains of digitalization – the three fundamental spheres of organization activity within which digitalization occurs: operational, analytical and collaborative. Early-adopters – organizations whose leadership teams are regularly among the first to apply new forms of digitalization. Efficient market – a market that provides maximal opportunities to producers and consumers to effect transactions with minimal transaction costs. Empowerment – one of the four engines of digitalization; providing humans facing decisions with timely, accurate and comprehensive information and with easy-to-use, relevant decision aids and business intelligence tools. Engines of digitalization – the four fundamental mechanisms through which digital technologies effect changes within organizations and their broader social/economic contexts: automation, control, empowerment and interaction. Firm – one of the two primary mechanisms (along with the market) for organizing economic activities; economic exchanges in a firm mainly occur through hierarchical structures and control structures. Also referred to as an organization. Globalization – the ongoing process of interaction and integration among the people, companies and governments of different nations. Incumbents – firms having operated in an industry for a long time and holding wellestablished business models, organization structures and resource control structures.

538

Interaction – one of the four engines of digitalization; enabling entities (human or digital) to engage in timely, meaningful dialogues with one another (overcoming barriers of space and time). Interoperability – when two or more digital solutions are able to seamlessly exchange data and able to apply these exchanged data. Linear value stream – sequence of value-adding steps within a pipeline ecosystem in which raw materials are assembled into components and then into finished valueunits that are delivered to consumers, either through a complex downstream process facilitated by intermediaries or through a simpler, direct-to-consumer downstream process. Market – one of the two primary mechanisms (along with the firm) for organizing economic activities; economic exchanges in a market mainly occur through pricing mechanisms and contractual mechanisms. Moore’s law – a characteristic of digital technologies, whereby their capability per dollar essentially doubles each year. Network ecosystem – a market-focused ecosystem in which a network of valueunit producers and a network of value-unit consumers are brought together by a network orchestrator. Network orchestrator – creates and manages the market environment and the transaction environment within which value-unit exchanges occur within a network ecosystem. Organization – one of the two primary mechanisms (along with the market) for organizing economic activities; economic exchanges in an organization mainly occur through hierarchical structures and control structures. Also referred to as a firm. Open – a technology that is available for use (and modification) by anyone, though some form of payment may be required to gain access to the technology. Operational domain – one of the three domains of digitalization; organizational activities involved in getting things done. Pipeline ecosystem – a market-focused ecosystem in which a producer organization targets a collection of value-units at one or more consumer segments and fashions a linear value stream involving numerous upstream, midstream and downstream organizations to deliver the value-units to consumers. Proprietary – a technology that is tightly controlled by its developer. Technology entrepreneurs – firms (often young and small) that bring specialized digitalization expertise to innovate, transform or disrupt certain aspects of an industry’s value stream or value-units. 539

Value-unit – the entities (information, a good or a service) being exchanged within a market-focused ecosystem. Vertically-integrated – when a producer in a pipeline ecosystem performs many, if not most, of the activities involved with upstream and downstream linear value stream processes.

CHAPTER 2: Digital Strategy Fundamentals Adaptive agility – the ability of a firm to aggressively introduce incremental enhancements into currently-executing business models. Agility – the ability of a firm, first, to detect potentially disruptive threats and opportunities and, then, to marshal the resources and managerial insights required to subdue threats and/or exploit opportunities. Business model – a simplified and aggregated conceptualization of the valuecreating, profitability-sustaining activities of an organization. Collision at the core – directing managerial attention and resources toward building relationships with digitalization leaders in order to understand and recognize business model innovations aimed at reinventing currently-executing business models. Core capabilities – an element of a business model that describes the tangible and intangible resources needed to successfully implement a business model’s value proposition and profit model. Cost model – describes the nature of the costs borne in producing revenue streams from an executing business model and how these costs will be controlled to provide requisite levels of profitability. Customer intimacy – a value discipline by which organizations tailor and shape products and services to fit increasingly segmented consumer needs and wants. Dynamic capabilities – an element of a business model that describes the intangible resources needed to (1) sense and assess opportunities for business model enhancement, replication and innovation, and (2) successfully implement these enhancements, replications and innovations. Dynamism – the ability of a firm to innovate, transform and disrupt by demonstrating strategic adaptability, speed and entrepreneurism. Entrepreneurial agility – the ability of a firm to aggressively introduce radical enhancements into currently-executing business models or to introduce new business models.

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Experimentation at the edge – directing managerial attention and resources toward understanding and recognizing business model innovations within adjacent industries and within emerging industries. Operational excellence – the value discipline by which organizations provide consumers with very reliable products and/or services at very competitive prices delivered with minimum difficulty or inconvenience for consumers. Product leadership – a value discipline by which organizations produce a continuous stream of new, innovative and stylish products/services. Profit model – an element of a business model that defines how an organization expects to be profitable; consists of revenue models and cost models. Reinvention at the root – directing managerial attention and resources toward understanding and recognizing the necessity to cannibalize existing core capabilities and dynamic capabilities by investing significantly in digitization and digitalization capabilities. Revenue model – an element of a profit model that describes where, when and how sustainable revenue streams will materialize when executing a business model. Stability – the ability of a firm to withstand disruptions by maintaining operational reliability and efficiency. Strategic experiment – a small-scale, tightly-contained competitive move taken to learn about a potential digital innovation or potential digital disruption. Strategic intent – a statement of competitive direction and purpose that directs digital strategists’ thought processes. Value disciplines – three sets of activities that are crucial in differentiating an organization from its competitors; an organization’s dominant value discipline strongly influences its executing business models. Value proposition – an element of a business model that defines how organization will distinguish itself within the market(s) that it has chosen participate. Pipeline organizations distinguish themselves by creating value consumers. Network organizations distinguish themselves by creating value participating communities.

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CHAPTER 3: Digitalized Business Models for Pipeline Ecosystems Big Data – high-volume streams of digitized data that are captured and organized for use.

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Big Data analytics – applying statistical and mathematical models to organized collections of Big Data. Data/document standards – policies and rules that allow data and documents to be accessed and used by value stream participants. Disintermediation – an intermediary is bypassed, thus shortening and narrowing a value stream. Economies of scale – the advantages that arise with increased volume of output. Economies of scope – the advantages that arise when a family of related goods are produced rather than a single good. Electronic Data Interchange (EDI) – an Era 1 form of industry-based sets of data/document standards. Intermediary – an organization whose capabilities are used to reach suppliers or end consumers. Intermediary transformation – an existing intermediary vertically integrates, thus becoming a producer. Intermediation – choosing to reach suppliers or end consumers through another organization. Long-tail phenomenon – the ability of digital markets to offer a far broader variety of value-units than could be offered in comparable physical markets. Make-versus-buy decision – a firm (or individual) decides between making an item or performing an activity itself (themselves) or having another firm (or individual) make the item or perform the activity. Pervasive connectivity – when smart devices across an ecosystem are interconnected, thus creating opportunities for anywhere, anytime interaction. Platform – assemblage of digital technologies that hosts digital and digitally-enabled resources. Primary processes – work activities directly involved in delivering value-units to customers. Production costs – direct costs to produce an activity or perform an activity. Reintermediation – a new intermediary is added to a value steam, thus lengthening and broadening the value stream. Self-regulation – an organization captures data associated with critical marketrelated transactions, monitors this data for problems, reacts responsively and 542

responsibly if and when problems arise, and keeps regulators and value-stream participants aware of these activities. Smart device – an assembled piece of digital technology containing the digital capability to sense, analyze and act on environmental signals. Social media complements – the opportunities made available to value-unit consumers to engage with the value-unit’s producer and/or retailer and with other consumers via social media. Stock holding – building up various kinds of inventories, thus providing buffers that soften the effects of poor demand forecasts. Support processes – work activities that provide direction, resources and oversight for primary processes. Transaction costs – additional costs involved (beyond production costs) when an item or activity is acquired from someone else. Value stream platform – a platform, hosting digitized data and documents as well as digitalized managerial and operational processes, that can be accessed and used by a value stream’s participants. Vertical integration – when a producer in a pipeline ecosystem performs many, if not most, of the activities involved with upstream and downstream linear value stream processes. World Wide Web (WWW) – an Era 2 one-to-many connectivity mechanism enabling organizations (and individuals) to access and use content stored across the Internet.

CHAPTER 4. Digital Strategy Formulation for Pipeline Organizations Barriers to competitive retaliation – tactics taken to prevent competitors from eroding an organization’s gained competitive advantages. Business model enhancement – incremental changes are made to one or more of the four elements of business models. Business model innovation – radical changes are made to one or more of the four elements of business models or a novel configuration of these elements is fashioned. Business model replication – a business model proven successful in one market is applied within an adjacent market. Business platform – a platform hosting digitalized operational and managerial processes. 543

Channel multiplicity – ensuring that a sufficient mix of interconnection channels are available to handle the data, messages and documents flowing to and from individuals and digital solutions so that a preferred channel is available for use. Complementary resources barrier – based on requirements for unique or rare non-digital resources in establishing a digitalized competitive advantage. Customer switching costs – the costs borne by a consumer choosing to move to a competing product/service. Data mart – an archive of organized data focused on a specific sphere of work. Data warehouse – a single, comprehensive archive of organized data. Digital platform – a platform hosting technology services. Digital resources barrier – based on an organization’s investment in unique or rare digital/digitalized assets and capabilities. Event visibility - making key events (as well as key non-events) known to the individuals and the digital solutions taking action so that actions can be taken. Global – a digital solution designed and built to be used by most of an organization’s work units. Local – a digital solution designed and built to be used by one or only a few of an organization’s work units. Loose-coupling – neither of the interconnected platforms needs to be modified in order that the data, messages and/or documents being exchanged are consistently interpreted across both platforms. Mission statement – answers the question: “What must we do to achieve our strategic vision?”. Modularity – each of a platform’s major functionalities, or modules, operates independent of other functionalities and obtains needed information or resources from a common coordinating module. Preemption barrier – based on an organization’s investments that limit competitors’ opportunities and incentives to undertake retaliatory action. Pricing mechanism – the means by which a value-stream participant captures its share of the value being created by the value stream. Project management capabilities barrier – based on an organization’s investment in needed project management capabilities.

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Strategic vision – answers the question: “What kind of organization do we wish to become?”. Tight-coupling – one or both of the interconnected platforms need to be modified so that the data, messages and/or documents being exchanged are consistently interpreted across both platforms. Well-architected platform – exhibits an appropriate balance in (1) the stability and agility of the hosted functionality, and (2) the costs of building, enhancing and extending platforms across functional, unit and organization boundaries.

CHAPTER 5. Digital Strategy and the External Sourcing of Capabilities Cloud computing – provisioning a pool of digital assets and digitally-enabled services such that these services can, on demand, be accessed and applied by clients via the Internet. Collaboration-based crowdsourcing – the crowdsourcing community collectively generates ideas, selects the most promising of these ideas, and refines these selected ideas into the single task outcome. Commodity capabilities – the capabilities that are required or are otherwise beneficial for an organization to operate, that do not contribute to competitive positions (aside from their absence), and that are readily available from external sources. Crowdsourcing – externalizing a capability to a community of individual agents. Externalization of a capability – transferring ownership and decision rights regarding a capability, the assets used in executing the capability, and/or the management of the capability from inside an organization’s boundary to outside this boundary. Loose-governance – increased discretion is given to the provider with the increased risk exposure managed through the client-provider relationship and by regularly assessing whether or not an engagement continues to prove beneficial for both the client and the provider. Multisourcing – contracting with multiple providers rather than a single provider. Offshore – the external provider of a capability is located in a different country than is the client. Onshore – the external provider of a capability is located in the same country as is the client.

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Outsourcing a capability – transferring ownership and decision rights regarding a capability, the assets used in executing the capability, and/or the management of the capability from inside an organization’s boundary to outside this boundary. Peripheral core capabilities – the capabilities that are necessary for an organization to gain and maintain its competitive positions, but that are not a source of competitive advantage. Prediction market – targets broad, diverse communities to predict events or outcomes. Social information – information formed through exposure to the contributions of other community members and these members’ expressed confidence in their contributions. Strategic core capabilities – capabilities that lie at the heart of an organization’s competitive advantage. Tight-governance – characterized by a constant, detailed and deep visibility into how a work activity is being carried out and the extent to which a comprehensive set of negotiated obligations is being met. Tournament-based crowdsourcing – the crowdsourcing community (working individually or in teams) submits finalized, independent task solutions; the crowdsourcer/client then selects one of these contributed solutions, or perhaps a few solutions, in exchange for financial or non-financial compensation.

CHAPTER 6. Digitalized Business Models for Network Ecosystems Blended organization – an organization that operates, to varying extents, as both a pipeline organization and a network organization. Complement – an entity that increases the perceived worth of a value-unit. Core transaction – the primary market exchange activity driving both producers and consumers to an ecosystem’s market platform. Critical mass – the point at which the number of product/service-adopters results in the product/service becoming dominant within its market space. Cross-side effect – existence of positive (or negative) effects felt by a community associated with a network ecosystem as the number of members increases with another of the ecosystem’s communities. Crowd-based capitalism – a two-sided market that brings together two crowds, or communities, of individuals: one community possessing an under-used asset or skill 546

(the value-unit) and the other possessing a short-term need for such an asset or skill. Market platform – the organized collection of digital and business platforms that hosts the content and functionalities that establish, operate and govern the ecosystem’s market. Money-side – a revenue-generating community associated with a network ecosystem. Multi-sided market – a network ecosystem with more than two actively participating communities. Network effects – where the worth of or demand for a value-unit grows as an exponential function of the number of current consumers of a value-unit and/or the number of complements available to these consumers. Network externality – where the worth of or demand for a value-unit grows as an exponential function of the number of current consumers of a value-unit and/or the number of complements available to these consumers. Same-side effect – existence of positive (or negative) effects within a community associated with a network ecosystem. Subsidy-side – an incentivized community associated with a network ecosystem. The sharing economy – an economy driven by crowd-based capitalism. Two-sided market – a network ecosystem in which a producer community and a consumer community are brought together to engage in value-unit exchanges. Winner-take-all-market – a market where the potential exists that a critical mass of consumers will adopt one producer’s products/services.

CHAPTER 7. Digital Strategy Formulation for Network Organizations Ancillary transactions – transactions associated with a network organization’s value propositions that bring communities other than producers and consumers to the platform. Market congestion – ensuring the ease by which producers and consumers are able to consider a sufficient number of alternatives in arriving at a satisfactory match. Market design – a network organization’s competitive moves aimed at enhancing the efficiency of its constituted market.

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Market platform design – a network organization’s competitive moves aimed at building market platform content/functionality in order to enhance community participants’ satisfaction with offered value propositions. Market safety – ensuring that market transactions are sufficiently safe such that producers and consumers are willing to reveal or act on confidential information and are willing to keep the transactions inside the market. Market thickness – ensuring sufficiently large numbers of producers and consumers such that a strong likelihood exists that satisfactory producer-consumer matching will occur. Side-switching – existing producers become consumers and/or existing consumers become producers. Spillover – when a taken action targeted at one purpose affects other purposes.

CHAPTER 8. Grappling with the Risks of Digitalization Authentication – techniques aimed at proving a person’s or a digital entity’s identity. Business platform operations – the execution of an organization’s digitalized operational and managerial processes that are hosted on business platforms (and on market platforms). Cybercriminal – uses hacking techniques and tools in order to take illegal actions for financial gain or to take over digital assets in order to launch a series of illegal actions. Data privacy – concerns that arise wherever personally-identifiable or other sensitive information is captured, collected, stored and used. Detection – putting in place software and manual scanning processes that identify problematic behaviors transpiring within digital platforms and business platforms. Digital assets – digital technologies (hardware and software), digitized data, and digitization/digitalization capabilities applied in configuring digital platforms and business platforms. Digitalization risk – the likely occurrence of digitalization-related incidents that have the potential to negatively impact an organization’s operational performance and/or competitive position. Financial loss – theft; fraud; extortion; destruction of uninsured facilities, equipment and materials; drops in stock valuations; regulatory fines; legal fees, court awards and out-of-court settlements; etc. 548

Graceful degradation – operations affected by a natural disaster do not immediately shut down, but instead gradually slow down, allowing time for affected operations to be shifted to other physical locations prior to a complete shutdown. Hactavist – uses hacking techniques and tools for the purpose of bringing attention to a social or political issue. Hardening a platform – installation of hardware, software and physical impediments that increase the effort required by a perpetrator such that all but the most determined perpetrators either bypass the platform (moving on to easier targets) or are so hindered that they quickly give up. Intellectual property loss – theft of digitized ideas, innovations and other forms of creative expression (e.g., trade secrets; blueprints; digitalized processes; proprietary digital content; the underpinnings of strategies and business models; etc.). Internal controls – the processing logic and rules embedded within digitalized financial reporting systems to ensure the correct handling of financial transactions and the accuracy of produced financial reports. Legal and regulatory requirements – digitalization-related statutory policies and rules requiring protective actions, most often aimed at preventing harm to others. Malicious intrusion – a perpetrator’s success in getting through an organization’s security-related defenses. Natural disaster – tornadoes, hurricanes, earthquakes, tsunamis, nuclear emergencies, collapsed dams, broken gas or water pipes, etc. Ongoing risk control – monitoring a risk area such that the incident occurrences are detected and resolved before excessive losses occur. Reputation loss – depreciation of an organization’s image or of its brands that undermines the trust and goodwill held by participants in the various market-focused ecosystems with which the organization participates. Revenue loss – short-falls in revenue streams or lost revenue streams traced to operational disruptions, reputation loss, the inability to respond effectively to competitors’ actions, etc. Risk assessment – estimating the risk exposure associated with a risk area. Risk assumption – accepting that losses are likely to arise if and when an incident occurs in a risk area, covering these losses through internal funds and third-party insurance. Risk deterrence – taking action to reduce the likelihood that an incident will occur in a risk area. 549

Risk exposure – the probability of a risk occurring multiplied by the expected loss to be borne if the risk occurs. Risk management – creating awareness and a common understanding across an organization’s members about the existence and nature of a risk domain; and, putting in place risk management policies, procedures and programs to ensure that critical risks in the domain are appropriately addressed by the appropriate individuals. Risk mitigation – tempering (as much as possible) the consequences of a risk incident by taking corrective actions. Risk planning – establishes the contexts within which risk management activities are carried out. Terrorist – uses hacking techniques and tools for the purpose of causing harm and havoc within an established geo-political order.

CHAPTER 9. Executive Mandates: Digital Strategy Chief digital officer (CDO) – senior executive/manager having approval authority for digitalization-related investments. Data monetization – bundling together well-defined sets of data and analytic models such that the intangible value of data is transformed into something of tangible value. Digitalization culture – an organization culture where competitive success largely relies on the capabilities and judgements of employees – working alone and in small groups – holding local knowledge and unencumbered by bureaucratic or overlyburdensome hierarchical constraints. Digitalized ecosystem mindset – a view of competitive spaces as markets characterized by high rates of business model evolution/innovation, high levels of information sharing and value co-creation by market participants, and high rates of participant entry/exit. Intangible digital assets – market, product, services and platform designs that attract, engage and retain large numbers of ecosystem participants; operational and analytical processes that capture, organize and exploit data regarding market events, about operational and managerial activities, and about participant beliefs, expectations, behaviors and perspectives; knowledge and skills held by an organization’s employees as well as its partners’ employees; digitalization reputation acquired by an organization; etc. Organization culture – the assumptions, values and norms of behavior collectively held by an organization’s members. 550

Social proof – a social influence mechanism aimed at producing coordinated behavior among individuals. Tangible digital assets – the commodity technologies (e.g., servers, routers, messaging services, Internet standards and software, etc.) that serve as the building blocks of digital platforms and of business platforms.

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