by Don Tapscott, David Ticoll and Alex Lowy
|Table of contents
The New Models of Wealth Creation
The Human and Relationship Elements of Digital Capital
|People: The Human Capital in the Business Web
|Marketing: Relationship Capital in the Web
Strategies for Business Webs
|How Do You Weave a B-Web?
|Harvesting Digital Capital
|About the Authors
Value innovation through business webs
The MP3 Story
"We record anything-anywhere-anytime," proclaimed Sam Phillips on his business card. Phillips was a white man who wanted black musicians to feel comfortable at Sun Records, his two-person recording studio in segregation-era Memphis, Tennessee. In July 1953, a shy-looking eighteen-year-old named Elvis Presley came by the studio and paid Phillips $3.98 to record his version of "My Happiness." The young man took home the sole copy of his vinyl disk. Although Elvis hung around the studio persistently after that, Phillips only twigged his potential a year later, when he launched the future star's career with a haunting cover of "That's All Right." Then, after 11/2 years of working his way up the hillbilly circuit, Elvis finally cut his first RCA hits.
If Elvis were trying to break into the music business today, then he would not need to wait 21/2 years to get national distribution. Instead, like thousands of others, he could use MP3, which fulfills the bold claim on Sam Phillips's business card. MP3 really does record-and distribute-any music, anywhere, anytime. It does so free and unmediated by agents and record companies.
Through Elvis's career and beyond, an oligopoly of industrial-age record companies and broadcast networks like RCA and CBS controlled the music distribution business. Today, their dominion is in tatters. While partisans quibble about its profitability, convenience, sound quality, or long-term prospects, the MP3 phenomenon has rent forever the rule book of this $38 billion industry.
The Fraunhofer Institute, a German industrial electronics research company, released MP3 in 1991 as a freely available technical standard for the compression and transmission of digital audio. The user "business case" for MP3 is simple: Buy a CD burner for three hundred dollars, and you can download and save an entire pirated Beatles collection on two CDs. At this point, you've made back your hardware investment, and now you can build the rest of your music library for the cost of the blank CDs.
Viscerally appealing to youngsters in the Net Generation demographic, MP3 attained critical mass in 1998, when it whirled through the Internet almost overnight. Millions of technology-literate kids and teenagers, high on music, low on cash, and sold on the mantra that "information wants to be free," used the Net to freely create and share MP3 software tools and music content. MP3 shows how internetworking and critical market mass can drive change with breathtaking speed. Piracy cost the music industry $10 billion in 1998; at any one time, more than half a million music files were available on the Internet for illegal downloading. While the recording industry scrambled to deal with this hurricane of music piracy, most people were not even aware that all this was going on!
MP3's success is the product of an Internet-based alliance-a business web-of consumers, businesses (content and software distribution sites like MP3.com, and technology manufacturers like Diamond, maker of the Rio MP3 player), and content providers (musicians). It exemplifies how business webs have risen to challenge the industrial-age corporation as the basis for competitive strategy.
MP3 meets our definition of a business web (b-web): a distinct system of suppliers, distributors, commerce services providers, infrastructure providers, and customers that use the Internet for their primary business communications and transactions. Without such an Internet-enabled system, MP3 would almost certainly never have succeeded-and certainly not as fast as it did.
Though the MP3 b-web is an informal, grassroots phenomenon, it has shaken the foundations of an entire industry. Most other b-webs emanate from businesses, rather than college and high school students. They have identifiable leaders who formally orchestrate their strategies and processes. But no matter where they come from, b-webs provide challenge and opportunity to every business. They are the only means for accessing and increasing what we call digital capital, the mother lode of digital networks.
Simply put, digital capital results from the internetworking of three types of knowledge assets: human capital (what people know), customer capital (who you know, and who knows and values you), and structural capital (how what you know is built into your business systems). With internetworking, you can gain human capital without owning it; customer capital from complex mutual relationships; and structural capital that builds wealth through new business models.
This book shows business leaders how to form and build reserves of such digital capital by harnessing the power of business webs.
Driving Forces of the Digital Economy
The question facing leaders and managers is not just "What is driving change in the economy today?" It is "What should I do to respond to all these changes?" This book is intended to help answer the second question. But before doing so, we will quickly describe the forces that drive the new economy, forces that are leading to the inevitable rise of the b-web.
The industrial economy depended on physical goods and services. Mass production addressed the problems of scarcity and the high costs of mobilizing raw materials, fabricating and assembling goods, and delivering them to their destinations. In the new economy, many offerings (like software and electronic entertainment) are nonphysical and knowledge-based, whereas the value of "physical" items (like pharmaceuticals and cars) depends on the knowledge embedded in their design and production.
Consequently, the economy shifts from scarcity to abundance. We can reproduce and distribute knowledge products like software and electronic entertainment for near zero marginal cost. Knowledge-intensive physical goods also become cheaper. Self-evident in the case of computer chips, this principle even applies to natural resources. Satellite imaging quickens the hunt for mineral resources. Ocean fisheries collapse, but the applied science of aquaculture fills markets with fish. Everywhere, knowledge yields new abundance.
Network economics drive the interlinked phenomena of increasing returns and network effects: Many (but by no means all) knowledge-based goods obey a law of increasing returns: once you have absorbed the cost of making the first digital "copy" (e.g., of a piece of software or an electronic publication), the marginal reproduction cost approaches zero resulting in huge potential profits. Certain goods also display network effects: The more widely they are used, the greater their value. The more people who buy videodisc players, the more manufacturers are motivated to publish titles; this in turn makes the players more valuable to the people who own them. In such situations, those who control the standards can make a lot of money. Other examples include PC operating systems, the Web, and word processing software.
As MP3 illustrates, hurricanes of change can hit hard, and without warning. To prepare for such events, managers in every industry must learn to lead and change in "Internet time."
Space and time have become elastic media that expand or contract at will. Global financial markets respond to news in an instant. Nonstop software projects "follow the sun" around the world each day. Online auctioneers host millions of sessions simultaneously, with worldwide bidding stretched over a week instead of the moments available in a traditional auction gallery.
The new economics of knowledge, abundance, and increasing returns precipitate long-term deflationary trends. Networked computing cuts the cost of doing business in every industry, which inevitably means better deals on just about everything. There is a lot of room for growth well into the twenty-first century, in both rich and poor countries. And growth with little or no inflation is the best kind.
In this world of abundance, attention becomes a scarce commodity because of three factors. First, no person can produce more than twenty-four hours of attention per day. Second, the human capacity to pay attention is limited. Third (a result of the first two and exacerbated by the Internet), people are inundated with so much information that they don't know what to pay attention to. To capture and retain customer attention, a business must provide a pertinent, attractive, and convenient total experience.
Industrial-age production, communications, commerce, and distribution were each the basis of entirely different sets of industries. Now, these activities implode on the Net. Industry walls tumble as companies rethink their value propositions. Car manufacturers reinvent their offering as a service-enhanced computer-communications package on wheels. Publishers confront today's Net-based periodical and tomorrow's digital paper; with the Web, all businesses must become publishers. Who will move in on your markets-and whose markets should you move in on?
To win in such an economy, you must deliver much better value at a much lower price. But no single company can be a world-class, lowest-cost provider of everything it needs. Another key transformation comes to the rescue: the driving forces of the digital economy slash transaction costs-the economic underpinnings of the integrated industrial-age enterprise. The twentieth-century enterprise is giving way to the b-web, driven by the disaggregation and reaggregation of the firm.
Disaggregation and Reaggregation of the firm
Why do firms exist? If, as Economics 101 suggests, the invisible hand of market pricing is so darned efficient, why doesn't it regulate all economic activity? Why isn't each person, at every step of production and delivery, an independent profit center? Why, instead of working for music publishers like Sony and PolyGram, doesn't a music producer auction recordings to marketers, who in turn sell CDs to the street-level rack jobbers who tender the highest bids?
Nobel laureate Ronald Coase asked these provocative questions in 1937. Some sixty years later, several thinkers, seeking to understand how the Net is changing the firm, returned to Coase's work.
Coase blames transaction costs (or what he calls the cost of the price mechanism) for the contradiction between the theoretical agility of the market and the stubborn durability of the firm. Firms incur transaction costs when, instead of using their own internal resources, they go out to the market for products or services. Transaction costs have three parts, which together and even individually can be prohibitive:
- Search costs: Finding what you need consumes time, resources, and out-of-pocket costs (such as travel). Determining whether to trust a supplier adds more costs. Intermediaries who catalog products and product information could historically reduce, but not eliminate, such search costs. Music distributor Sony, through its Epic Records label, hires a stable of producers and marketers, cuts long-term deals with artists, and operates its own marketing programs all in the name of minimizing search costs for itself and consumers.
- Contracting costs: If every exchange requires a unique price negotiation and contract, then the costs can be totally out of whack with the value of the deal. Since Sony owns Epic Records, it does not need to negotiate a distribution deal when Epic signs a new artist like Fiona Apple.
- Coordination costs: This is the cost of coordinating resources and processes. Coase points out that with "changes like the telephone and the telegraph," it becomes easier for geographically dispersed firms to coordinate their activities. Industrial-age communications enable big companies to exist. Sony's internal supply chain includes finding and managing talent, and producing, marketing, and distributing recorded music.
Coase says that firms form to lighten the burden of transaction costs. He then asks another good question. If firm organization cuts transaction costs, why isn't everything in one big firm? He answers that the law of diminishing returns applies to firm size: Big firms are complicated and find it hard to manage resources efficiently. Small companies often do things more cheaply than big ones.
All this leads to what we call Coase's law: A firm will tend to expand until the costs of organizing an extra transaction within the firm become equal to the costs of carrying out the same transaction on the open market. As long as it is cheaper to perform a transaction inside your firm, says Coase's law, keep it there. But if it's cheaper to go to the marketplace, don't try to do it internally. When consumers and artists use the Net as a low-cost marketplace to find one another and "contract" for tunes, the Sonys of the world must face the music.
Thanks to internetworking, the costs of many kinds of transactions have been dramatically reduced and sometimes approach zero. Large and diverse groups of people can now, easily and cheaply, gain near real-time access to the information they need to make safe decisions and coordinate complex activities. We can increase wealth by adding knowledge value to a product or service-through innovation, enhancement, cost reduction, or customization at each step in its life cycle. Often, specialists do a better value-adding job than do vertically integrated firms. In the digital economy, the notion of a separate, electronically negotiated deal at each step of the value cycle becomes a reasonable, often compelling, proposition.
This proposition is now possible because the Net is attaining ubiquity (increasingly mobile through wireless technologies), bandwidth, robustness, and new functionality. The Net is becoming a digital infrastructure of collaboration, rich with tools for search transactions, knowledge management, and delivery of application software ("apps on tap").
Call it hot and cold running functionality and knowledge. This explosion, still in its early days, is spawning new ways to create wealth. A new division of labor that transcends the traditional firm changes the way we design, manufacture, distribute, market, and support products and services. Several examples illustrate the success enjoyed by companies that employ this new division of labor.
- MP3.com is a Web-based music distributor that uses, but does not control, the MP3 standard and that offers legal, non-pirated music. In September 1999, it listed 180,000 songs from 31,000 artists, ranging from pop to classical to spoken word. Music downloads are free and nearly instantaneous. Fans also purchased 16,000 CDs online for a typical price of $5.99.
- Global Sources is a b-web that provides manufacturers, wholesalers, and distributors with access to products from 42,000 Asian makers of computers and electronics, components, fashion items, general merchandise, and hardware.
- The GE Trading Process Network (GETPN) enables companies to issue fully documented requests for quotations to participating suppliers around the world via the Net, and then to negotiate and close the contract. Through a partnership with Thomas Publishing Company, a publisher of buying guides, GETPN provides an even bigger transactional database for manufacturing procurement.
Consider James Richardson, owner of a two-person industrial-design firm in Weston, Connecticut. In 1998, he received a contract to design and build a running-in-place exercise machine. He set out to find manufacturers of membrane switches, essentially pressure-sensitive circuits printed on Mylar polyester film. Richardson first went to the Thomas Register Web site. Then he explored other sites on the Internet. He found dozens that listed products and described the companies that made them, their delivery schedules, and whether the products met international quality standards. Then he hunted up assemblers, who described their quality levels. Richardson produced a set of engineering drawings on his computer and e-mailed them to a list of prospective suppliers. A few weeks later, his chosen suppliers were mass-producing the exercise machine. Richardson had set up a virtual factory without leaving his office or investing any of his own money. He created a new business model by using internetworking to cut transaction costs.
Adrian Slywotzky defines a business model as "the totality of how a company selects its customers, defines and differentiates its offerings (or response), defines the tasks it will perform itself and those it will outsource, configures its resources, goes to market, creates utility for customers, and captures profits. It is the entire system for delivering utility to customers and earning a profit from that activity." He points out that companies may offer products or they may offer technology, but these offerings are embedded in a comprehensive system of activities and relationships that represent the company's business design. Slywotzky emphasizes activities and relationships, both of which are changing dramatically.
In this ever-changing tapestry, which thread should you grab first? Our research and experience suggest that you should begin with disaggregation-and its natural complement, reaggregation. Richardson's story shows that because the Net cuts transaction costs, a company can create value through a disaggregated business architecture. The challenge facing today's manager is to turn disaggregation from threat to opportunity.
Webster's defines the verb disaggregate as "to separate into component parts," and reaggregate as "to cause to re-form into an aggregate or a whole." These themes apply both to the transformation of the value proposition and to the design of new organizational structures for enhanced value creation. In the digital economy, Coase's law goes into overdrive. On the one hand, the discrete value-creating activities of firms, even entire industries, become easier and cheaper to disaggregate out to the open market. On the other, the coordination tools of the digital infrastructure enable firms to expand massively in highly focused areas of competency. In this book, we describe how companies like eBay and Cisco Systems provide models for doing both these things simultaneously.
Disaggregation enables entirely new kinds of value, from entirely new kinds of competitors. As a result, relegating digital technologies to nifty Web-site designs or superficial cost-saving initiatives are potentially fatal errors of an industrial-age mind-set. Disaggregation should begin with the end-customer's experience-the value proposition. It breaks out that experience as well as the goods, services, resources, business processes, and organizational structures that make it possible into a set of logical components. Effective strategists honestly face the many weaknesses inherent in industrial-age ways of doing things. They redesign, build upon, and reconfigure the components to radically transform the value proposition for the benefit of the end-customer. Planners must imagine how networked digital technologies enable them to add new forms of value every step of the way, to each component part. Then, they creatively reaggregate a new set of value offerings, goods, and services, as well as the enabling resources, structures, and processes.
The Wall Street Journal, founded in 1889, spent its first century as an aggregated collection of content (news, listings, advertising), context (the physical newspaper), and infrastructure (printing, physical distribution), bundled into a single tightly integrated offering. With the arrival of the Internet, the Journal, working with partner companies and even readers, disaggregated these elements into separate component parts, and then reaggregated them into an entirely new value proposition. The old value proposition was a physical package of yesterday's news, delivered to your doorstep or newsstand. The new one is a twenty-four-hour customizable information service, increasingly available anywhere at the point of need. Subscribers can use the online Wall Street Journal Interactive (WSJI) to track their personal stock portfolios, set up the "newspaper" to present the stories they care about the most, join online discussions, and access the Dow Jones Publications Library to research just about any business topic. For Internet time, the WSJI value proposition may not be quite up to snuff: Avid readers note that some "current" news stories are as much as twenty-four hours old (and more on weekends)!
Disaggregated from its physical wrapper, the content is now available through a variety of electronic contexts, including the publication's own WSJI, and a variety of third parties like a Microsoft Web channel, the PalmPilot wireless network, and mobile phones. These services share an underlying delivery infrastructure the Internet but each enables a different shade of customer value. The Journal's own Web site posts the entire contents of the printed newspaper and much more, which the serious reader can customize. Microsoft and PalmPilot provide quick, though sometimes perforce superficial, news updates for desktop and mobile users, respectively. The Journal redefines and enhances its value proposition to meet a particular set of customer needs. A specific cast of players not only Microsoft and Palm Computing, but also network companies like BellSouth participates in the b-web that supports a specific distribution context. All collaborate and compete in the creation of value, with an eye to the changing needs and expectations of the digital end-customer.
In the digital economy, the essence of the value proposition itself is destabilized. But so is the structure that enables the creation of value the vertically integrated firm. The Wall Street Journal can no longer rely on its own printing presses and delivery trucks to mass-produce its daily information feed. To get the new, customized message out, it must now form partnerships with Microsoft, Palm Computing, and many others.
The reaggregation of the value proposition leads companies to change in other important ways. The Journal adds content to the Web site that readers of the print edition never get to see. It learns how to present and customize this content for Internet users. Microsoft and Palm extend their mandates from technology to information services. While intensifying its focus on its core competencies, each company uses partners to broaden its range of customer attractions. This is the payoff of reaggregation for the digital economy.
Popular approaches to business-model innovation
We present here a brief tangent to our main focus: popular approaches to business-model innovation that turned out to be forerunners of the b-web phenomenon.
The first stage of innovation was the vertically integrated industrial-age corporation, with supply-driven command-control hierarchies, division of labor for mass production, lengthy planning cycles, and stable industry pecking orders. Henry Ford's company the first archetypal industrial-age firm didn't just build cars. It owned rubber plantations to produce raw materials for tires and marine fleets for shipping materials on the Great Lakes. Hearst didn't just print newspapers; it owned millions of acres of pulpwood forest. IBM's most profitable products during the Great Depression were cardboard punch cards, and the company built and sold clocks until well into the 1970s. Mania for diversification reached an absurd peak in the conglomerate craze of the 1970s, when companies like ITT Industries poured billions into building Rube Goldberg-like corporate contraptions that simply did not hang together.
It took sixty years for the global business environment to converge with the potential implicit in Ronald Coase's insights. As the twentieth century unfolded, the accelerating progress of computer and communications technologies peeled back transaction costs at an ever-increasing rate. In the late 1970s, the vertically integrated mass-production manufacturing company went into crisis. North American companies had become dozy, fat, hierarchical, and bureaucratic in the twenty-five years after World War II. They gradually awoke to a U.S. defeat in Vietnam, an oil price shock instigated by a Middle Eastern cartel, and frightening competition from Japan and other Asian countries. Japanese manufacturers shook the ramparts of the industrial heartland steel and automotive. Customers flocked to their innovative, reliable, and cheaper products. In 1955, American-owned companies built 100 percent of the cars sold in the United States. Thirty years later, their share had dropped below 70 percent. And other industries, from textiles to computers, felt the same heat.
Managers responded with innovation in two business dimensions: process and structure. Process innovations included concepts like agile manufacturing, total quality, supply-chain management, and business process reengineering (BPR). These techniques helped fend off the challenges of offshore competition, cost, and customer dissatisfaction. They remain vitally important in their updated forms of today. But the techniques did not attack the core issues of value innovation and strategic flexibility. BPR's single-minded focus on cost cutting often led to forms of corporate anorexia that did more harm than good.
Structural (business model) innovations were important forerunners of the b-web. Popular approaches to business model innovation included the virtual corporation, outsourcing, the concept of the business ecosystem, and the Japanese keiretsu.
At the height of their crisis of self-confidence, North American managers and strategists stumbled across the keiretsu. It struck terror in their hearts. Keiretsu members in automotive, electronics, banking, and many other industries had suddenly emerged as global samurai. Rooted in centuries-old fighting clans, a keiretsu is a semipermanent phalanx of companies bound by interlocking ownership and directorates. Keiretsu battled aggressively with one another and on the international front, drawing strength from a strong us-versus-them mind-set. Keiretsu, along with cartels, were not just a strategic option for Japanese companies. They defined the business environment: The Japanese Fair Trade Commission estimated that over 90 percent of all domestic business transactions were "among parties involved in a long-standing relationship of some sort." The strength of keiretsu also proved to be their downfall. Their tight, permanent linkages the very opposite of an agile business structure help to explain Japan's economic difficulties during the latter half of the 1990s.
Ironically, now that the keiretsu have been increasingly discredited in Japan, they have become fashionable in Silicon Valley as companies in all sectors discover the power of strategic partnering via the Internet. Proponents like the industry analyst Howard Anderson have not developed a new view of the keiretsu. Rather, they use the term as a pop epithet to describe partnerships ranging from loose associations to corporate conglomerates like AOL/Time Warner. In our view this application of the term is not helpful and obfuscates the much more important underlying dynamics of the business web.
Though in part a response to the keiretsu, the North American virtual corporation was a fundamentally different idea. Proponents mystically described it as "almost edgeless, with permeable and constantly changing interfaces between company, supplier, and customers. Job responsibilities will regularly shift, as will lines of authority even the very definition of employee will change as some customers and suppliers begin to spend more time in the company than will some of the firm's own workers." Other proponents depicted the virtual corporation as good, but elective, business medicine. But in Japan, keiretsu are like oxygen: Breathe them or die. Also, a virtual corporation is a temporary, opportunistic partnership: "Complementary resources existing in a number of cooperating companies are left in place, but are integrated to support a particular product effort for as long as it is economically justifiable to do so." Keiretsu relationships, on the other hand, are institutional and permanent. As we describe in this book, b-webs are, in one sense, more like keiretsu than virtual corporations. They are not merely good medicine, but part of the "air" of the digital economy. And a b-web-like the now twenty-year-old Microsoft software alliance can go on for a very long time. However, unlike a keiretsu, a b-web is not necessarily a permanent arrangement, nor does it need to use ownership to integrate its participants.
Outsourcing was a less ambitious idea than the virtual corporation: Pick a non-core activity and contract it out to a supplier who can do it more cheaply or better than you. Outsourcing is often a way to unload a problem function like transportation or information technology. But outsourcing relationships can be tough. Outsourcer and outsourcee often perceive that they are in a zero-sum financial game, and they lack openness or trust. Such a mind-set characterized supply-chain relationships in the automotive industry for years.
More fundamentally, in a world of b-webs, outsourcing is dead, not because big firms will take over all business functions, but rather the opposite. Managers will no longer view the integrated corporation as the starting point for assigning tasks and functions. Rather, they will begin with a customer value proposition and a blank slate for the production and delivery infrastructure. Through analysis, they will parcel out the elements of value creation and delivery to an optimal collection or b-web partners. The lead firm in a b-web will want to control core elements of its digital capital like customer relationships, the choreography of value creation and management processes, and intellectual property. Depending on the particulars, partners can take care of everything else.
None of these models - keiretsu, virtual corporation, or outsourcing fully reflected how the world was changing by the mid-1990s. Then, with blazing insight, James Moore announced the business ecosystem, "an economic community supported by a foundation of interacting organizations and individuals the organisms of the business world." The ecosystem includes customers, suppliers, lead producers, competitors, and other stakeholders, who "coevolve their capabilities and roles, and tend to align themselves with the directions set by one or more central companies."
Moore's ecosystem metaphor illuminated the workings of the personal computer industry and others like it, in which many companies and individuals innovate, cooperate, and compete around a set of standards. Bill Gates, the Henry Ford of the information age, pioneered and popularized ecosystem management techniques that have become common principles for b-web leadership: Context is king. Ensure voluntary compliance with your rules. Facilitate independent innovation. Harness end-customers for value creation. Go for critical mass fast. Moore's ecosystem metaphor, though powerful, has limitations. It evokes a natural world in which biology and animal instinct rule, instead of human thought, judgment, and intentional actions. Animal instinct may be a big part of business life, but it does not explain everything.
By the mid-1990s, only a handful of corporations had made genuine progress toward any of these popular approaches to business model innovation. Two factors stood in their way. For industrial-era firms, all these approaches required too much of a break from established management cultures. And even the most advanced information technologies of the time client server computing and electronic data interchange (EDI)- reinforced a centralist, hub-and-spoke business architecture. These technological systems had to be custom built, and at great expense. The Internet's universal-knowledge utility did not yet exist.
At this point in the mid-1990s, the sense of anticipation was nearly palpable. The worlds of business and communications were on the eve of revolutionary changes. It was as if the air had gradually become saturated with a combustible mix of gases; the tiniest spark would set off a vast explosion. The explosion came with the creation and discovery of the World Wide Web a revolutionary new medium of human communications based on a few simple lines of software code. By the end of the decade, the Net was driving over $160 billion in transactions per year, most performed in and by b-webs.
© Don Tapscott, David Ticoll and Alex Lowy
Email this article | Respond to this article