Chapter 1 Excerpt for Ecosystem Edge
1
Addressing the Disruption Imperative
THE SHOCKWAVES IN DETROIT WERE ALMOST DEAFENING. The world had just learned that Tesla Inc. had surpassed the market capitalization of General Motors (GM) to become the most valuable automaker in the United States.
A week earlier, it had overtaken the value of Ford, the company that had pioneered the modern auto industry. GM and Ford had 225 years of experience in the automobile industry between them—while Tesla had all of 15 years. Tesla sold 84,000 vehicles in 2016 compared with GM’s worldwide sales of around 10 million vehicles and Ford’s 6.6 million. Some questioned the wisdom of these valuations given Tesla’s position as a minnow in the industry that had yet to deliver a profit.1 The sceptics were not wrong; stock market sentiment had changed by the end of 2017, and GM’s share price had surged by close to 30 percent while Tesla struggled with the basics of building a car and rolling out its new mass-market Model 3. However, despite these misgivings, it was proof, if proof were needed, that the auto industry had entered a period of disruption.
As far back as 2011, Bill Ford, who headed up one of the most successful automakers of all time, had recognized that selling more cars simply “wasn’t going to cut it” either for Ford or for the industry.2 The emergence of electric vehicles, car sharing and ride sharing, and autonomous driving technology promised to radically transform the automotive industry and undermine car makers’ traditional business models.
New players were entering the space, including Uber and technology companies such as Google and Apple. In the words of Bill Ford, “We now have disruption coming from every angle, from the potential ways we fuel our vehicles to the ownership model.”3 Ford’s former CEO Mark Fields echoed that sentiment in 2015, noting that the auto industry was at an inflection point, with technology driving rapid innovation and “new, non-traditional partners and competitors now interested in our business.”4
While incumbent automakers retained their competitive advantage in manufacturing and brand, they were at square one when it came to technologies such as autonomous driving and car sharing/ride sharing applications. The impact of car sharing, as pioneered by Zipcar in 2000, could prove to be significant. Research has found that a single shared vehicle in developed, urban car-sharing markets replaces the purchase of 32 vehicles. The study estimated that car sharing had already displaced 500,000 car purchases and had the potential to cause 1.2 million lost vehicle sales through 2020.5 More recently, a leading industry analyst had suggested that the emergence of shared driverless cars could lead to a 40 percent drop in US auto sales over the next 25 years.6 It was clear that the world’s established automakers would have to fight to stay relevant.
More and more companies in a wide range of industries are facing similar disruption to their traditional formulas for making money that have served them well for decades. The music business has been up-ended with the rise of new ways to consume music. The top twenty brick-and-mortar retailers in the United States announced that they had shut down three thousand stores in 2017. Macy’s, J.C. Penney, Sears, and Kmart were just a few of the chains that had announced sweeping closures.7 The major restructuring of the French retail giant Carrefour in January 2018 was yet another example of the consequences that e-commerce had on the traditional retailers. In 2017, the Financial Times identified four more industries ripe for disruption by technology, the sharing economy, start-ups, and new business models: Travel agents; manufacturers and distributors of small components, in part because of 3-D printing; financial advisers, with the rise of robo-advisers; and auto repairers due to low-maintenance electric vehicles and fewer accidents with driverless cars.8 The banking industry too is poised for disruption by blockchain-based financial services and other forms of “fintech.” Other sectors such as fast-moving consumer goods (FMCG) are being disrupted by the greater consumer choice and price transparency that comes with online marketplaces. Their media strategies are being challenged by social media, and calls to guarantee the sustainability of their products and traceability in their supply chains, along with the prospect of new technologies that allow consumers to personalize the products they buy, are further disrupting their extant business models. New technologies also mean that instead of selling jet engines, companies such as Rolls Royce, Pratt and Whitney, and General Electric sell “aircraft power by the hour.”9 Companies like Michelin sell road kilometers instead of tires. In effect, new technologies such as digitalization, the application of big data analysis and machine learning, and artificial intelligence (AI) are disrupting business models in industry after industry.
How should you deal with the wave of disruption that will eventually hit your industry? How do you become one of the disruptors? The specifics of successful strategies will obviously vary with the situation. However, we believe they all share one characteristic: A successful strategy, in the future, will depend on how well you proactively lead your ecosystem, by engaging with different partners who bring fresh competencies and capabilities that will fuel innovation and transform your organization. You need to catalyze a deep and vibrant ecosystem of partners around your company. This goes far beyond working more closely with your supply chain, open innovation, or co-innovation with your customers.
The nature of innovation is changing: Instead of just product and process innovations, customers are now demanding innovative, integrated solutions to complex needs and problems. To deliver these integrated solutions you will need to access the capabilities of partners, drawing on know-how and capacity in a wide variety of related industries.
The potential to reap economies of scale has also changed. In the past, scale economies were driven by your company’s size. Today and tomorrow, the benefits of scale will increasingly depend on the total sales of your ecosystem, including both you and all of your partners.
The concept of competing on speed also needs to be rethought. Companies used to think about speed as being “first to market.” Today, however, launching your product or service ahead of competitors is a poor predictor of who will come dominate the market. Instead, the winners are increasingly those companies that are first to scale up an innovative idea. Speed to scale, capitalizing on the magnitude of the opportunity rather than simply opening it up, is key. Harnessing the network effects that your ecosystem can provide, where every additional user increases the value of the product or service to all the other partners and customers in the ecosystem, is frequently decisive in winning the race to scale. The Facebook ecosystem, for example, reached five hundred million users in 2010, just six years after the company was founded.10 That same year, MySpace users declined to seventy million, having plateaued at just over one hundred million users.11 This was despite being launched one year earlier and the backing of its huge new owners, News Corporation. Speed to scale had won out. While Myspace went into decline, two years later Facebook had surpassed one billion users. It now has over two billion active monthly users.
To benefit from these fundamental shifts in the competitive landscape requires a radical transformation of your business model. It involves learning to proactively catalyze, shape, and lead an ecosystem in ways that will harness its potential to radically transform your business model to cope with disruption, uncertainty, and rapid technological change. It means learning to thrive in a world where competition that pits one ecosystem against another replaces rivalry between individual companies.
Catalyzing the development of a powerful ecosystem around your company will also transform your prospects by giving you what we call the “ecosystem edge.” It will help you leverage powerful network economies; focus your company on what it is really good at; enable you to harness the power of partners in the areas where they excel; and help you innovate faster, become more agile, and grow in a world where digitalization is now infusing every industry. These benefits are now more than “nice to have”; companies must transform themselves by creating ecosystems today in order to survive and prosper tomorrow.
To understand the practical steps you and your team can take to achieve the ecosystem edge, we focus on eight core examples in this book: Alibaba Group, Amazon.com, ARM, athenahealth, Dassault Systèmes S.E., The Guardian, Rolls-Royce, and Thomson Reuters. We selected these firms from a variety of different industries to demonstrate that it is not only platform players or e-commerce companies that can harness the potential of ecosystem advantage. There is also huge potential for companies in traditional industries, such as manufacturing, mining and energy, pharmaceuticals and life sciences, and fast-moving consumer goods (FMCG), to enhance their success and respond to industry disruption by embracing ecosystem thinking. We also selected these case studies from different continents: an ecosystem is not unique to a particular location. We found ecosystems delivering innovation, greater scale economies, and increased profits both in industrialized and emerging economies.
In order to explain what this entails, let’s begin by taking a look at Alibaba, China’s giant e-commerce company, which has transformed retail in China and beyond through its many innovations.
Alibaba: The Power of Ecosystem Advantage
Alibaba Group is one of the best examples of an organization that has successfully leveraged the power of its ecosystem to gain competitive advantage. At its initial public offering (IPO) on the New York Stock Exchange in September 2014, this Chinese conglomerate was valued at over $225 billion.12 Its market capitalization has since soared to reach almost $530 billion in January 2018. The group and its affiliate companies span twenty-five business units that include the world’s largest business-to-business marketplace (Alibaba.com), business-to-consumer e-commerce (Taobao and Tmall.com), online payment (Alipay.com), and cloud computing (Aliyun.com). More recently, it has expanded into new areas, including digital media and entertainment, credit scoring, travel services, and virtual mobile telecommunications. Its affiliate, Ant Financial Services Group, includes the world’s largest money market fund, Yu’e Bao, which had 325 million customers and assets exceeding $170 billion by early 2018.
For the year ending December 31, 2017, Alibaba Group’s revenues exceeded $39 billion. Yet it had achieved this massive scale and spread of operations with little more than sixty-six thousand employees (with just seven thousand more in Ant Financial, itself estimated to be worth more than $150 billion in 2018). The Group’s e-commerce businesses were more than twice the size of Amazon.com, a company with over five hundred fifty thousand staff. So how did Alibaba achieve such results, recording annual sales revenues of over $590 thousand per employee?
The first clue as to how Alibaba has created so much new value can be found in the opening paragraph of the Group’s website: “We operate an ecosystem where all participants—consumers, merchants, third-party service providers and others—have an opportunity to prosper.”13 Alibaba had come to believe that the route to success lay in understanding how to enhance its own competitive advantage by promoting and leading the development of its ecosystem developed with time and experience. Key to this was a focusing on the creation of attractive opportunities for an increasingly diverse range of partners.
But Alibaba’s journey also shows some of the hurdles that must be overcome to gain an ecosystem edge. Learning how to harness the power of its ecosystem was not always easy for the Group. Alibaba had started out as a classic intermediary between buyers and sellers. Learning to become an ecosystem enabler required it to make difficult choices that included abandoning some of its existing profit streams. In the face of huge uncertainty, and accepting that a large network of partners would never be fully controllable, Alibaba’s founder, Jack Ma, had a strong belief in the power of the ecosystem model.14 To date, this belief has proven right.
Alibaba’s experience with its Taobao and Tmall.com units illustrates some of the key characteristics of ecosystem strategies and the requirements for its success. In 1998, Ma was asked by a company sponsored by the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) to assist Chinese companies to become involved in “electronic commerce,” based on private networks, to facilitate electronic data interchange. Ma believed the real potential lay in open networks enabled by the Internet, and so he gathered eighteen people in his apartment and outlined his vision in a discourse lasting two hours. The group was so inspired that they clubbed together $60,000 to launch “Alibaba”—a name they felt embodied the idea of “open sesame to the treasures of the world.” Alibaba’s origins thus trace back to 1999, when it first launched the website Alibaba.com, a business-to-business (B2B) portal to connect Chinese manufacturers with overseas buyers.
Alibaba did not have a clear vision of what their future ecosystem would look like at the time. The idea was simply to make the internet accessible, trustworthy, and beneficial for all. Those noble aspirations, however, were not enough to ensure that the new venture was financially sound. Alibaba.com had a rocky time in its early years. Although it earned a margin by selling products through its site, the costs involved in handling new products (such as uploading and maintaining product details on the site) was high. By 2001 it was burning through the $25 million funding it had raised from investors, such as Japan’s Softbank, Goldman Sachs, and Fidelity, at the rate of $2 million per month, and was left with less than $10 million in the bank.
The first phase (of three broad stages) in Alibaba’s transition to becoming an ecosystem enabler came in response to this cash drain. Alibaba moved from a pure platform intermediary to become a service provider, charging membership fees to users. It had already recognized that reaping economies of scale was critical to spread fixed costs and drive down unit costs. But it now understood that it would never achieve the scale it was aspiring to if it continued to act as a principal buyer or seller in its own right. For that massive scale, Alibaba would need to start thinking only about growing the size of its own operations to harness the power of a huge number of partners who could take the business beyond its own limited capabilities at the time. That, in turn, meant making it easy for partners to develop their own businesses, limiting its own activities, and focusing on selling Alibaba’s support to potential buyers and sellers.
The launch of Taobao heralded the second stage in developing an ecosystem: Taobao was conceived as a marketplace that encouraged others to serve customers. Alibaba role was to concentrate on providing the “platform” through which e-commerce could flow, and take a commission for connecting buyers and sellers. It was evident that the platform would need to be standardized as much as possible to gain scale economies. Additionally, partners needed to be able to differentiate themselves on that standardized infrastructure platform. To achieve this mix of standardization and differentiation, limiting the boundaries of the platform would be key.
“Our objective was to develop a platform of infrastructure that can attract a wide range of partners and boost growth and scale,” recalled Wang Jian, then chief technology officer of Alibaba Group. He went on to explain that Taobao had spawned a myriad of partner businesses: from companies that designed sophisticated shop-fronts for vendors and creators of advertising right through to companies that recruited models for photo shoots. Wang Jian also drew attention to Alibaba’s policy of nurturing small partners, and commented, “Small customers can become big customers, so the technology for both should be the same. Alibaba wants to make sure small customers have a future.” But during phase 2, Taobao was still acting as a kind of intermediary or “middleman” between buyers and sellers. That had to change. As Ming Zeng, the then group strategy officer put it, “We realised our ability was so limited compared to the potential of the market as well as the task facing us.” As Taobao developed, “it learned a lot of painful lessons by trying to over-control and becoming the bottleneck,” he added.15 The need to step back and move from intermediary to ecosystem orchestrater, was one of those key lessons. And because it meant surrendering significant control to partners, it was a difficult truth to swallow.
This led to a third stage in the emergence of ecosystem thinking at Alibaba: that it needed to become an “ecosystem enabler” and focus on becoming a provider of e-commerce, infrastructure, and services for all e-commerce market participants. Doing so would allow Taobao to gain the network advantages associated with large numbers of buyers and sellers. If Alibaba could position Taobao as “the place to go” for consumer e-commerce, it would trigger a positive spiral whereby the larger it grew, the more attractive it would become for buyers and sellers. By 2008, this thinking had led to the adoption of the “Big Taobao” strategy that aimed to encourage a large number of diverse potential participants to join and exploit new opportunities while addressing their challenge of reaching out to the vast but underdeveloped Chinese consumer market. The idea of becoming the leader of a thriving ecosystem with its own momentum, driven by partners joining and exiting, expanding in new directions, had taken root.
In order to successfully transition from an intermediary to ecosystem enabler, Taobao needed to reduce its role as the controller of activities around the platform. It now encouraged shop owners to take the initiative of working with other participants in the ecosystem, such as other sellers, providers of complementary services and the online shoppers themselves. It thus began to encourage shop owners to organize more joint marketing activities, and to work more directly with providers of other services that could improve their offerings.
This shift of focus to becoming an enabler for the development of a broader and deeper ecosystem around Taobao and Tmall.com also required Alibaba to change its revenue model. In 2009, advertising made up 85 percent of the revenues of Taobao and Tmall.com, and came from various sources including paid items appearing prominently in search results and additional fees for prime advertising positions on the sites. But reliance on these advertising and transactions fees would have to be reduced in order to enable the growth of the ecosystem and improve service to customers. Growth in Alibaba’s revenues and profits would have to come from Taobao and Tmall.com opening new revenue streams and sources of value from which Alibaba could capture a share. As Ming Zeng explained to us, “Because you are no longer taking a cut as a middleman, an ecosystem enabler has to be continually finding innovative ways to create new and unique value added from which it can take a profit. Revenue growth will come from taking a small cut on an ever-expanding volume of interactions of many types.”
To become an ecosystem enabler, Alibaba had to learn, therefore, to stop doing things; in some cases, even things that had become sizeable activities, such as running special promotions for some product categories. Some of these decisions were relatively easy, while others were more difficult. Observed Wang Jian,
It was very clear that Alibaba should not sell products—but the boundaries of the ecosystem are not easy to determine. Take software services. In principle, Alibaba knows it should leave them to partners, but in the short-term partners may not be willing or equipped, and so it would be easier for Alibaba to provide this service. But that would lead to unsustainable complexity and fragmentation. The solution hitherto has been for Alibaba to provide the basic building blocks, such as the exchange platform and a very rudimentary CRM system for every shop owner on Taobao. Alibaba is clear that it will not provide anything that is useful only to a single seller or even a small group of sellers—it must be offerings that are used by large numbers of participants.16
To maintain the health of the ecosystem, Alibaba also found that it was critical to resist the temptation to encroach on its partners’ businesses. Brian Li, then vice president of strategy, explained, “Someone in Alibaba will, perfectly reasonably, say: ‘we see a new application is becoming popular, why don’t we build one to do this?’ But a good ecosystem leader needs to say ‘no’; we should instead encourage partners to build this type of app, so that we draw on their capabilities and drive improvement and learning. By [Alibaba] taking this approach, users now have a choice of multiple apps within our ecosystem.”
Fundamental to Alibaba’s thinking was the belief that if it could create value for the end customer, it would find a way to earn money for itself. This meant focusing first on creating customer value, and then thinking how to capture and share a portion of that value. The Wangwang instant messaging feature on Taobao is a good case in point. It is of great value to buyers and sellers; it helps to build trust. Alibaba also learned that many Chinese buyers wanted to see the physical address of the seller on the website before they would trust them; so Taobao provided addresses even though suppliers argued that it was unnecessary in a world of electronic commerce. Likewise, Alipay ensured that the net proceeds of each sale were transferred to sellers once the delivery had been acknowledged by a buyer—in contrast to competitors such as 360buy which kept the money for a month after the sale to enhance their cash flows.
Ming Zeng explained how this fit into Alibaba’s ecosystem thinking, “Alibaba is a hub, so everything needs to go through it. Conceptually that enables you to charge a toll for passing through, which is our revenue. The higher the flow through, the more our revenues.”17 It was through this change in mind-set that Alibaba was able to create new business models to deliver growing profits.
An example of the new business model is the creation of “Taobao Ke,” a traffic aggregation system developed by Alibaba’s employees that won a CEO Innovation Award from Ma. Taobao Ke aggregates and analyses user data from more than five hundred thousand websites, receiving data on billions of page views per day. It starts by Alibaba agreeing with a website to carry a link that would direct potential customers to a Taobao store. The owner of the shop on Taobao agrees to pay a commission of around 10 percent of the gross sales when a lead comes through that website. The website owner receives 90 percent of that commission and Taobao retains 10 percent (or 1 percent of the gross sales value achieved). This kind of arrangement was common across the internet. But Taobao Ke developed new ways of adding value from analyzing and using data to improve the match between a Taobao store and the websites to which it was linked to achieve that required technology-heavy capacity that could analyze in an automated way the contents of a website, and also work out which of the one million-plus Taobao stores were most likely to be of interest to its users. Alibaba then proposes the optimal links to both Taobao storeowners and websites. This improves the value and efficiency of the arrangement for both parties. Alibaba adds even more value by making the system dynamic, using the mass of data accessed through Taobao Ke to continually learn and improve the matching between Taobao stores and other websites.
Taobao Ke is, therefore, an example of the kind of co-learning opportunities that ecosystem thinking creates. Storeowners learn more about what kind of websites are useful “shop windows,” as it were, to attract businesses. This could even vary by time of day or location. A wide variety of websites (including noncommercial information and community sites) would understand how to create a new revenue stream from click-throughs. Utilizing this new knowledge generated a growing profit pool. The partners improved their yield from each visitor. Alibaba itself generated a substantial stream, taking a small toll from each of the between five hundred million and one billion users that moved through Taobao Ke every day.
While Alibaba could not completely control its ecosystem, it could play a leadership role by acting as an enabler and catalyst for the development of the ecosystem. As a pivotal player in the ecosystem, it could influence and shape its future evolution. On the other hand, there was also a downside of being the hub in the ecosystem because, as Ming Zeng says, “every problem comes at you.” Despite this burden, he also pointed out a corresponding upside, “You are sitting at the hub of a system that generates lots of new knowledge so you can continuously learn from experience, problem solving, learning by doing, and contact with the front line.”18 Hence, being at the center of all flows of information gave Alibaba the opportunity to steer the whole network in ways that generated new value and profit streams, without actually controlling it.
Alibaba also discovered another insight that all ecosystem leaders need to take on board: a recognition that knowledge creation in the ecosystem is much greater than your own learnings—even as the “ecosystem leader.” Considerable learning also occurred between partners within the ecosystem, which could improve performance and strengthen the ecosystem even when it did not involve Alibaba directly. Sometimes, Alibaba needed to tap into the cross-communication and learning taking place between partners to help the process of discovering new value and profit opportunities along. At other times, that intervention was unnecessary.
The social networking sites around Taobao were a good example of why Alibaba had to reassess continually what role it should play. Alibaba had originally set up a social network site called Tao Jianghu within Taobao, with the aim of connecting younger users and creating a buzz in this group around the site. Over time, many similar social networks emerged around Taobao. None reached a scale sufficient to support the Taobao ecosystem as a whole; and instead, the proliferation of small social networking platforms created internal competition within the Taobao ecosystem. As a result, Alibaba had to take the initiative, and catalyze the growth of a single, vibrant social network that would match the Taobao identity and support its business model.
The success of Alibaba illustrates many of the advantages of ecosystems that we advanced above: ecosystems can generate new sources of customer value; enable new business models; access diverse partner capabilities and knowledge; and reap huge network economies. Alibaba also demonstrates how an ecosystem can ignite a positive spiral where successive improvements in the offering combined with easy access and greater choice attracts yet more customers. This growing customer base, in turn, attracts new partners who bring new capabilities and ideas that further improve the quality and convenience it offers to customers.
Alibaba’s experience also provides our first inkling into some of the things an ecosystem leader needs to do to catalyze, foster, and leverage their ecosystem: provide a compelling vision of the opportunity; step back and make room for partners; foster joint learning among partners; capture the data and knowledge the ecosystem generates to open up new revenue streams; and focus on the increased profits that come from enabling the ecosystem to grow rather than squeezing it dry for short-term returns.
Notes
1. Mohanbir Sawhney, “Why Investors Should Think Twice before Buying into Tesla,” Fortune, April 11 2017, http://fortune.com/2017/04/11/tesla-market-cap-general-motors-ford/.
2. Bill Ford, “A Future beyond Traffic Gridlock,” online video, March 2011, TED Talks, https://www.ted.com/talks/bill_ford_a_future_beyond_traffic_gridlock.
3. Ernest Gundling, “Disruption in Detroit: Ford, Silicon Valley, and Beyond,” Berkeley Haas Case Series, University of California, July 1, 2016, http://cases.haas.berkeley.edu/documents/best_case_award/2016_2_ford_58….
4. Gundling, “Disruption in Detroit.”
5. “AlixPartners Study Indicates Greater Negative Effect of Car Sharing on Vehicle Purchases,” AlixPartners, press release, February 5, 2014, http://legacy.alixpartners.com/en/MediaCenter/PressReleases/tabid/821 /articleType/ArticleView/articleId/950/AlixPartners-Study-Indicates-Greater-Negative-Effect-of-Car-Sharing-on-Vehicle-Purchases.aspx#sthash.5aEKm3np.m8yxsDxo.dpbs.
6. Gundling, “Disruption in Detroit.”
7. Mike Timmermann, “These Major Retailers Have Closed More than 5,000 Stores in 2017,” Clark, December 13, 2017, http://clark.com/shopping-retail/major-retailers-closing-2017/.
8. “Five Industries under Threat from Technology,” Financial Times, December 26, 2016, https://www.ft.com/content/b25e0e62-c6ca-11e6–9043-7e34c07b46ef.
9. Aircraft power by the hour is a term trademarked by Rolls Royce, but widely used in the aircraft engine industry to describe a programme to provide the aircraft operator with a fixed engine maintenance cost over an extended period of time.
10. “Speed to Scale,” Future Agenda, https://www.futureagenda.org/insight/speed-to-scale.
11. Kevin Kelleher, “How Facebook Learned from MySpace’s Mistakes, Fortune, November 19, 2010, http://fortune.com/2010/11/19/how-facebook-learned-from-myspaces-mistak….
12. All currency is in US dollars unless stated otherwise.
13. “Culture and Values,” Alibaba Group, https://www.alibabagroup.com/en/about/culture.
14. Peter Williamson and Michelle Wang, “Alibaba Group’s Taobao: From Intermediary to Ecosystem Enabler,” University of Cambridge, 2014, Judge Business School, case 10 (Case Centre case number 314-139-1, https://www.thecasecentre.org).
15. Ibid.
16. Ibid.
17. Ibid.
18. Ibid.