Unbundling the corporation
The forces that fractured the computer industry
are bearing down on all industries. In the face of changing interaction costs
and the new economics of electronic networks, companies must ask themselves the
most basic of all questions: what business are we in?
In the late 1970s the computer industry was dominated by
huge, vertically integrated companies such as IBM, Burroughs, and Digital
Equipment. With their vast advantages of scale and huge installed base of users,
these companies seemed to be unassailable. Yet just ten years later, power in
the industry had shifted: the behemoths were struggling to survive while an
army of smaller, highly specialized companies was thriving. What happened?
The industry’s transformation can be traced
back to 1978, when a then-tiny company, Apple Computer, launched the Apple II
personal computer. The Apple II’s open architecture unlocked the computer
business, creating opportunities for many new companies that specialized in producing
specific hardware and software components. Immediately, the advantages of the
generalist—size, reputation, integration—began to wither. The new
advantages—creativity, speed, flexibility—belonged to the specialist.
The story of the
computer industry illustrates the crucial role that interaction costs play in
shaping industries and companies. These costs represent the money and time
expended whenever people and companies exchange goods, services, or ideas.1 The exchanges can occur within a company, among companies,
or between a company and a customer, and they can take many everyday forms,
including management meetings, conferences, phone conversations, sales calls,
reports, and memos. In a real sense, interaction costs are the friction in the
economy. Taken together, they determine the way companies organize themselves
and form relationships with other parties. All else being equal, a company will
organize in whatever way minimizes overall interaction costs.
Apple’s open architecture sharply reduced
interaction costs in the computer industry. By conforming to a set of
well-documented standards, specialized companies could, for the first time,
work together easily to produce complementary products and services. As a
result, tightly coordinated webs of companies—such as Adobe Systems, Apple,
Intel, Microsoft, Novell, and Sun Microsystems—could form and ultimately
compete effectively against the entrenched, vertically integrated giants. Many
of the new companies grew very large very quickly, but they never lost their
focus on specialized activities.
The moral of the story is that changes in
interaction costs can cause entire industries to reorganize rapidly and
dramatically. Today, that fact should give all managers pause, for the world
economy is on the verge of a broad, systemic reduction in interaction costs.
Electronic networks, combined with powerful PCs, are permitting companies to
communicate and exchange data far more quickly and cheaply than ever before. As
business interactions move on to electronic networks such as the Internet,
basic assumptions about corporate organization will be overturned. Activities
that companies have always believed to be central to their businesses will
suddenly be offered by new, specialized competitors that can do those
activities better, faster, and more efficiently. Executives will be forced to
ask the most basic and discomfiting question about their companies: what
business are we really in? The answers will determine their fate in an
increasingly frictionless economy.
One company, three
businesses
Beneath the surface of most companies are
three kinds of businesses—a customer relationship business, a product
innovation business, and an infrastructure business. Although organizationally
intertwined, these businesses differ a great deal
THE THREE BUSINESES
The role of a customer relationship business
is, obviously, to find customers and build relationships with them—for example,
the marketing function of a bank or a retailer’s focus on drawing people into
its branches or stores. Another set of employees—loan officers or store clerks,
perhaps—assists customers and tries to build personal relationships with them.
Still other employees may be responsible for questions and complaints,
processing returns, or collecting customer information. Although these employees
may belong to different organizational units, they have a common goal: to
attract and hold on to customers.
The role of a product innovation business is
to conceive of attractive new products and services and figure out how best to
bring them to market. In a bank, employees in various product units or in a
centralized business development function are responsible for researching new
products (such as reverse mortgages) and ensuring that the bank can bring them
to market successfully. In a retail business, buyers and merchandisers perform
the product innovation role, constantly searching for interesting new products
and effective ways of presenting them to shoppers.
The role of an infrastructure business is
different again: to build and manage facilities for high-volume, repetitive
operational tasks such as logistics and storage, manufacturing, and
communications. In a bank, the infrastructure business builds new branches,
maintains data networks, and provides the back-office transactional services needed
to process deposits and withdrawals and present statements to customers. For
retailers, the infrastructure business constructs new outlets, maintains
existing outlets, and manages complex logistical networks to ensure that each
store receives the right products at the lowest possible cost.
These three businesses rarely map neatly to a
corporation’s organizational structure. Rather, they correspond to what are
popularly called “core processes”—the cross-functional work flows that stretch
from suppliers to customers and, in combination, define a company’s identity.
Managers talk about their key activities as
“processes” rather than as “businesses” because, with rare exceptions, they
assume that the activities ought to coexist. Almost a century of economic
theory underpins the conventional wisdom that the management of customers,
innovation, and infrastructure must be combined within a single company. If
those activities were dispersed to separate companies, the thinking goes, the
interaction costs required to coordinate them would be too great.
Working from that assumption, large companies
have in recent years spent a lot of energy and resources reengineering and
redesigning their core processes. They have used the latest information
technology to eliminate handoffs, cut waiting time, and reduce errors. For many
companies, streamlining core processes has yielded impressive gains, saving
money and time and giving customers more valuable products and services.
But managers have found that there are limits
to such gains. Sooner or later, companies come up against a cold fact: the
economics governing the three core processes conflict. Bundling them into a
single corporation inevitably forces management to compromise the performance
of each process in ways that no amount of reengineering can overcome.
Take customer relationship management. Finding
and developing a relationship with a customer usually requires a big
investment. Profitability hinges on achieving economies of scope—extending the
relationship for as long as possible and generating as much revenue as possible
from it. Only by gaining and retaining a large share of a customer’s spending
can a company earn enough to offset the up-front investment. Thus, customer
relationship businesses naturally offer customers as many products and services
as possible, which requires an intensely service-oriented culture.
Contrast that kind of business with a product
innovation business, in which speed, not scope, drives the economics. The
faster an innovation business moves a product or service from the development
shop to the market, the more money the business makes. Culturally, product
innovation businesses concentrate on serving employees, not customers. They do
whatever they can to attract and retain the talent needed to come up with the
latest and best product or service. They reward innovation, and they try to
minimize administration.
If scope drives customer relationship
businesses and speed drives innovation businesses, scale is what drives
infrastructure businesses. Such businesses generally require capital-intensive
facilities, which entail high fixed costs. Since unit costs fall as scale
increases, pumping large amounts of product or work through the facilities is
essential for profitability. As a result, the culture of infrastructure
businesses reflects a one-size-fits-all mentality that abhors all customization
and special treatment.
The regional Bell operating companies
(RBOCs)—local telephone carriers in the United States—provide a good example of
how these tensions can play out. An RBOC’s retail telephone operation is a
customer relationship business; it focuses on acquiring customers and keeping
them happy. By contrast, the wholesale telephone operation is an infrastructure
management business; it maintains the RBOC’s physical communications facilities
and furnishes specialized support services such as network management. To
maximize economies of scale, the RBOCs could lease their wholesale facilities
to telephone service resellers, which focus on the customer relationship
business. But the telephone companies are wary of entering into such alliances
because they fear that resellers will drain customers away from their own
retail telephone businesses.
RBOCs have, in other words, deliberately
limited the growth and profitability of their infrastructure businesses to
protect their customer relationship businesses. That decision has encouraged
specialized infrastructure businesses, which operate their own fiber-optic
networks, to enter the competitive fray in metropolitan areas, creating a
further threat to the RBOCs.
Most senior managers make such compromises
because they believe, or assume, that they have no option. How, after all, can
a core process be removed from a company without somehow undermining its identity
or destroying its essence? Such a mind-set, though historically justified, is
now becoming increasingly dangerous.
Organizational fault lines
Under the pressures of deregulation, global
competition, and advancing technology, a number of industries are already
fracturing along the fault lines of customer relationship management, product
innovation, and infrastructure management. The newspaper industry is one. Not
so long ago, all three core processes were tightly integrated within most
newspapers. A paper took on full responsibility for attracting its customers
(both readers and advertisers) and for developing most of its product (that is,
the news stories presented in its pages). A paper also managed an extensive
infrastructure, printing its editions on its own presses and distributing them
with a fleet of its own trucks.
Today the industry is beginning to look very
different. Much of the typical newspaper’s product is outsourced to specialized
news services; an average newspaper depends heavily on wire services,
syndicated columnists, and publishers of specialty magazine inserts for the
words and images filling its pages. In addition, many newspapers aspire to shed
their scale-intensive printing facilities and to rely instead on specialized
printers to produce the paper each day. As newspapers move away from product
innovation and infrastructure management, they can concentrate on the customer
relationship portion of the business, helping to connect readers and
advertisers. The Los Angeles Times, among other papers, is creating special
sections, geared to particular regions or interests, that help advertisers
target specific sets of readers more accurately. Such unbundling is making the
newspaper business less capital-intensive, a development that permits more
resources to be devoted to building customer relationships.
An influx of specialized companies has also
begun to reshape the pharmaceutical industry. Some product innovators in
biotechnology, notably Amgen, Genentech, and Myriad Genetics, are focusing on
specific techniques such as gene mapping. Others, including Medicis
Pharmaceutical and Bausch & Lomb, are concentrating on specific
disciplines—dermatology, for instance. Larger drug companies, rather than
financing product development efforts in all these areas, are taking equity
stakes in or allying with such niche players. Roche Holding, for example, has
purchased over two-thirds of Genentech, and Merck has entered into a
collaborative research and licensing agreement with Aurora Biosciences. On the infrastructure
side of the business, big drug companies have begun to outsource the planning
and execution of large-scale pharmaceutical trials to contract research
organizations such as Quantum. And big distribution specialists, including
McKesson and Cardinal, now warehouse and deliver most drugs.
As these and other industries have yielded to
the pressures of unbundling, established companies have faced a series of hard
choices. They have had to rethink their traditional roles and identities, to
challenge their organizational assumptions, and, in many cases, to make
fundamental changes in the way they operate. Now, as electronic commerce
reduces interaction costs throughout the economy, more and more companies will
face equally tough, if not tougher, decisions.
Organization and the Internet
To see into the future
of business organizations, you need only look at how Internet companies are
organizing today. Portal businesses such as Yahoo! increasingly focus on
managing customer relationships, relying on other companies to provide
innovative products and services based on the World Wide Web, on the one hand,
and infrastructure management, on the other. Many people still think of Yahoo!
as a search engine, but in fact its searching product is provided by another
company, Inktomi, an innovator whose expertise in parallel computing enables
its engine to search millions of Web pages almost instantly. Yahoo!, meanwhile,
has forged relations with big Internet-access providers, such as AT&T, that
manage a large portion of the Internet’s infrastructure. Yahoo! can thus
concentrate on attracting customers, gathering data on them, and connecting
them with both advertisers and merchants. It is positioned to become what we
call an “infomediary”—a company whose rich store of customer information
permits it to control the flow of commerce on the Web.2
Because electronic commerce has such low
interaction costs, it is natural for Web-based businesses to concentrate on a
single core activity—managing customer relations, product innovation, or
infrastructure management. Not that all current Internet companies are pure
players. We would argue, though, that hybrid models are transitional, required
by the infancy of electronic commerce. As the Internet industry matures, mixed
models will become less attractive and less sustainable.
As electronic commerce spreads out into other,
more traditional industries, they too will begin to fracture. Take the
automotive business. Small, entrepreneurial companies, such as Autobytel.com
and Autoweb.com, have recently emerged on the Web and are already gaining
control over customer relationships. These companies’ sites provide car buyers
with a broad range of information about current models and pricing. The sites
then collect detailed data about the customers and their preferences and use
that information to refer customers to appropriate automobile dealers. In 1997
Web site referrals accounted for about 2 percent of all nonfleet new-car
sales—a small percentage but one representing 300,000 cars, or $6 billion in
revenue. And J. D. Power & Associates predicts that one-third of all
new-car buyers will purchase cars using the Web by the year 2000.
As infomediaries gain further control over
customer purchases and, more important, over customer information, car
companies will have to rethink the role of the traditional automobile dealer.
Dealers could give up their customer relationship business entirely and focus
narrowly on the infrastructure business (managing showrooms, for example),
while independent, on-line infomediaries take over the role of acquiring and
managing customer relationships. Car manufacturers, meanwhile, may decide—or be
forced—to unbundle their businesses, outsourcing the role of customer
relationship management to an infomediary, increasing the proportion of
manufacturing they outsource to subcontractors, and focusing on product
innovation. As infomediaries develop a deeper understanding of each customer,
they could play an ever more central role in determining which make and model a
customer buys, eventually coming to fulfill virtually all of a customer’s
car-related needs.
A road map for unbundling
Although industries will fracture, they won’t
necessarily break into many small pieces. In fact, the structure of only one of
the three businesses—product innovation—is likely to be characterized by large
numbers of small businesses competing on a level playing field with low barriers
to entry. The product innovator’s need to provide a fertile environment for
creativity tends to favor smaller organizations, as does its need for speed and
agility in bringing products to market.
The other two businesses will probably
consolidate quickly as a small number of large companies assume dominance.
Since economies of scope are necessary in the customer relationship business,
it is likely that only a few big infomediaries will survive. America Online’s
decision to acquire Netscape, with its popular Netcenter Web portal, provides
strong evidence that the consolidation of this business is well under way.
Similarly, in the infrastructure business, economies of scale create
irresistible pressures to form large, focused enterprises.
Once a company decides where it wants to
direct its energies, it will probably need to divest other businesses. That
will be a big challenge. Few senior managers of large companies have ever
attempted a systematic divestiture program; such divestitures as have occurred
have usually been spin-offs of recent acquisitions whose expected synergies
never materialized. Even AT&T’s highly publicized divestiture of its
computer and telecommunications equipment businesses, NCR and Lucent,
respectively, falls largely into this category. The closest most companies have
come to the kind of divestiture we are talking about is the establishment of
outsourcing relationships in which infrastructure management activities such as
logistics, manufacturing, or data processing are contracted to outside
providers.
Divestiture is, of course, a radical step. In
most cases, executives would need to perceive a significant and immediate
threat before considering such aggressive surgery. For that reason, the first
divestiture programs will probably be launched by computing,
telecommunications, media, and banking companies whose markets are undergoing
major technological or regulatory change. Companies in other industries will be
able to learn from the successes—and mistakes—of these pioneers.
If a company has chosen to compete in customer
relationship or infrastructure management, where size matters, divestiture
won’t be enough; such a company will also need to build scope or scale through
mergers and acquisitions. Each acquired company will probably have to go
through a similar process of unbundling—shedding unneeded businesses to help
finance the next wave of acquisitions and integrating the remaining businesses
into the existing operation. The secret of success in fractured industries is
not just to unbundle but to unbundle and then rebundle, creating a new
organization with the capabilities and size required to win.
Rebundling will be a very different process
from the vertical integration that has often characterized traditional
acquisition programs. Because companies will be focusing on a single
activity—relationship management or infrastructure management—their
acquisitions will be aimed at achieving horizontal integration. They will seek
to build scope or scale within their own industry and then to leverage their
capabilities across related ones.
Senior managers will face many painful decisions as they make
the wrenching changes needed to realign their businesses. Although the choices
may be difficult, time will probably be short. Once interaction costs begin to
fall, an industry can reorganize remarkably quickly—as did the computer
industry. Sources of strength can turn into sources of weakness almost
overnight, and even the most successful company can swiftly find itself in an
untenable position.
byJohn Hagel III and Marc Singer
http://www.mckinsey.com/insights/strategy/unbundling_the_corporation?cid=other-eml-cls-mip-mck-oth-1507
No comments:
Post a Comment