With all due respect to Ronald Harry Coase, some of the Nobel Prize-winning British economist’s ideas about why firms exist have passed their best-before date.
Decades ago, when other intellectuals were content simply accepting the existence of corporate black boxes, Coase explored their raison d’être. Using scholarship money won as an undergraduate, he set out across America’s industrial heartland to ask business leaders at major companies like General Motors and Ford why they did what they did.
Coase concluded that firms exist to do things in-house when the transaction cost of going to market can be reduced or eliminated. The world wasn’t quick to recognize Coase’s genius, even after he published his now-famous essay called “The Nature of the Firm” in 1937. But his insights eventually acquired an army of followers. As a result, most businesses today remain designed to meet a fundamental principle: functions are performed within the boundaries within which they can be most efficiently performed.
Note the multiple uses of the word “within” in the previous sentence. That’s the problem. As things stand, too many companies cling to the premise that their role in the value chain is defined by only looking within their own four walls. And with that outdated view, they can’t see how their role relates to that of others in the value chain, or how, by working differently with partners, they can better serve the customer.
As The Economist noted when Coase died in 2013, communications were poor, and economies of scale could be vast, when “The Nature of the Firm” was published, which is why carmakers of yesteryear often owned engine-makers and other suppliers. But that was 80 years ago—when an average house cost under US$5,000 and people still travelled by airships.
Times change. And there is no question that digital technologies have disrupted the models that customarily defined how we conduct business. This leaves monolithic corporations across all industries with a clear choice: they can continue to lose ground and eventually watch their business crumble, or they can take charge of their own future by embracing the new way of integrating functions and becoming an ecosystem organization.
Changing from a monolithic business to an ecosystem organization is difficult. It requires reconfiguring the company’s entire value chain—taking it apart piece by piece and then putting it back together with a new structure. This structure includes not only the company’s internal operations but also multiple external partners that truly work together toward the single goal of serving the customer better.
“If success seems to rely on what happens within the company’s four walls, everyone will concentrate only on internal operations, knowing they will be evaluated and compensated based on this focus.”
Further, this transition requires the company to develop a new mindset, one that enables it to view the whole value chain from the customer’s perspective—not the company’s—and to better meet the customer’s needs—not the company’s.
One of the main obstacles to making this difficult transition is the company’s own current processes, most of which have been designed specifically for internal efficiency, and for maintaining the status quo and keeping it running efficiently. The processes are not designed to work with external partners, and so they are inefficient in an ecosystem. Many processes need to be recast completely.
Culture, a reflection of what the company thinks is most important to its success, is another obstacle. If success seems to rely on what happens within the company’s four walls, everyone will concentrate only on internal operations, knowing they will be evaluated and compensated based on this focus. They will shift their concentration only when the company develops an external perspective and rewards a culture that reflects this point of view.
Fear can also get in the way. The fear of doing something totally new is greater than that of doing nothing—even when remaining a monolithic organization will almost certainly jeopardize the company’s future.
The fourth main obstacle is technology. The most common refrain among monolithic organizations is that their technology will not support an ecosystem organization. However, this idea reflects a misunderstanding of technology. Only the technology the organizations are using within their own four walls prevents companies from building the organizations they need. There is no shortage of technology outside the organization that they can use to move forward—they just need to acquire it.
Most companies will also need to address unsuspected deficiencies before starting to reconfigure their value chain. To do that, they need to have a granular view of margin flow across the value chain so they can look at financial margins at the total system level. At present, companies often don’t know where margins are for the players along the value chain because when they look at margin flow, they do so at a high aggregate level, not with the granularity necessary to understand how the distributors do, or don’t, benefit from the ecosystem.
They also need to have the right skillset for being an ecosystem organization. A skillset designed only for simple function optimization (like that of the monolithic organization) must be replaced with one built around an end-to-end view of the value chain. This skillset must be both deep and wide. Having supply chain, product, and other functional experts is important, but not enough. These skilled workers must be integrated with people who think beyond the company and understand the entire value chain from the product’s manufacture to its final use.
Finally, companies need to know their true market advantage. Is it pricing structure, manufacturing capabilities, marketing skills, or something not as obvious? Without this clarity, a company won’t know what it adds to the value chain or which players would make the best partners by contributing attributes the company lacks. This clarity will help a company select the right partners and work with them in ways that better serve the customer.
Although the path may be riddled with challenges, companies across industries have begun transforming into ecosystem organizations. Today, about 15 per cent of both the retail and high-tech industries lead the way, with others, such as the pharmaceutical industry, following suit.
Pharmaceutical companies making the transition, especially biologic manufacturers, are discarding the industry’s ineffective, longstanding distribution system. In this complex supply chain, drugs move at a glacial pace from one distributor to the next (local, regional, national, international, and more). Likewise, information about patient needs flows in the reverse direction, stopping at each distributor before eventually—sometimes weeks later—reaching the manufacturer.
This process is ineffective for the distribution of most drugs, but particularly for delivering the biologics now at the forefront of medical care for people needing highly personalized treatment. These are sophisticated, high-cost drugs that often have very short shelf lives and are highly sensitive to heat and contamination—for example, the recently available biologic medication Harvoni, which cures hepatitis C. Today, many manufacturers either ship biologics broadly so they will be available where they are needed, when needed, or they ship them only to select locations. In the latter case, they often are not available when patients elsewhere require them. This process wastes drugs and money, and leaves many patients untreated.
Biologic drug manufacturers are accepting total responsibility for overall end-to-end product distribution, for making sure each distributor focuses beyond just getting the product to the next point along the supply chain, and for smoothing the transmission of customer information back through the chain. As a result, their biologic drugs no longer sit past their expiration dates on shelves in the wrong locations, but are distributed where they are needed immediately. These manufacturers are saving millions of dollars each year, and patients are getting the personalized, sophisticated drugs they need in time to improve their health.
Like these pharmaceutical manufacturers, companies in other industries are building ecosystem organizations that help them better serve the customer. For example, in the property and casualty insurance industry, Allstate is moving far beyond the old four-wall view of how to price automobile insurance with Arity, its telematics unit. While still offering blanket insurance rates, the rates for Arity’s new micro-services are based on environmental conditions, customer lifestyles, and other factors that influence risk. Among these factors—reaching beyond the driver’s age and location—are real-time usage (determined by digital information on when the car sits unused and when it is driven) and weather conditions that might raise the driver’s risk level. Eventually, the company will include information such as whether the driver is under the influence of alcohol or drugs, is emotionally upset, or is running late and therefore rushing to be somewhere on time.
In the industrial sector, Predix, GE’s multi-billion-dollar online platform, helps companies move beyond their own four walls. With Predix, companies can collect real-time information from the factory, evaluate the quality-assurance risks of using third parties, bring the right materials and equipment to the table just when they are needed, and follow deliverables all the way through the supply chain. Companies can also share value across the supply chain, which will include an array of partners extending well beyond what monolithic organizations, with their inward view of business and opportunities, would ever consider.
As these and other companies have already learned, becoming ecosystem organizations can lead to previously unobtainable benefits for themselves and their customers.
They can, for example, greatly improve their relationship with their partners in the value chain. No longer will they have a transactional relationship with only one or two partners, a relationship based on a win–win or a win–lose proposition. Ecosystem organizations can look at the total system value around the delivery of the product to ensure that all members of the ecosystem understand the end goal and their incentives for helping achieve it. In addition, they will no longer maintain an outsourcing relationship with others in the value chain. Outsourcing will have morphed into a collaborative relationship in which all partners share the common goal of transparently serving the customer as if they were only one company.
Furthermore, ecosystem organizations can take advantage of newly available technologies and platforms to more easily connect the dots across the multidimensional value chain, gaining the ability to more quickly generate innovation and insights. This ability will further enable the organizations to pursue new and expanded opportunities at a much faster pace than ever before—cutting market responsiveness from months down to days—and to exponentially multiply their capabilities and grow their business.
Becoming an ecosystem organization is a difficult challenge. But the choice between remaining a monolithic organization with a limited future or transitioning into this new structure with multiple benefits for both the company and the customer should be an easy decision for every company to make.