Guiding the Digital Transformation

of Organizations - Second Edition

Vallabh Sambamurthy & Robert W. Zmud

Part 1. Digital Strategy

Legerity Digital Press LLC

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 Guiding the Digital Transformation of Organizations
Part 1. Digital Strategy
By Vallabh Sambamurthy and Robert W. Zmud

Second Edition Copyright © 2017

First Edition Copyright © 2012

All rights reserved. No part of this publication shall be reproduced, distributed, or

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ISBN 978-0-9995347-0-0

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 TABLE OF CONTENTS

PART 1. DIGITAL STRATEGY

Chapter 1 Digital Innovation and Disruption…………………………………………… 2

Chapter 2 Digital Strategy Fundamentals………………………………………………. 26

Chapter 3 Digitalized Business Models for Pipeline Ecosystems……………. 44

Chapter 4 Digital Strategy Formulation for Pipeline Organizations………… 70

Chapter 5 Digital Strategy and the External Sourcing of Capabilities……. 102

Chapter 6 Digitalized Business Models for Network Ecosystems……………. 123

Chapter 7 Digital Strategy Formulation for Network Organizations………. 150

Chapter 8 Grappling with the Risks of Digitalization………………………………. 177

Chapter 9 Executive Mandates: Digital Strategy……………………………………… 206

Glossary ………………………………………………………………………………………………….. 537

 Chapter 1. Digital Innovation and Disruption

Today there are clear signs of intense, continuous and unprecedented waves

of economic competition. Traditional industries are being disrupted by the arrival of

new firms and, more significant, the emergence of new industries offering novel ways

of fulfilling customer needs and desires. Firms that were household names at the

turn of the century (Walmart, Sears, Cisco, and Dell) are now replaced with new firms

(Facebook, Apple, Google1 and Tesla).

Since 1983, Fortune magazine has published an annual ranking of the most

admired companies. Though methodology and criteria have varied somewhat over

the years, the overall process has remained remarkably consistent. For the 2016

list, these criteria involved assessments of a candidate firm’s: ability to attract and

retain talented people, quality of management, social responsibility, innovativeness,

product/service quality, use of corporate assets, financial health, long-term

investment value, and effectiveness in doing business globally.2

Table 1-1 provides a ranking of the top-ranked most admired companies from

1983 to 2016. In compiling this listing, three-year intervals and companies’ average

rank in the annual top-ten of most admired companies were used. Note two key

insights. First, a number of companies have multiple appearances, suggesting that

these companies were steered by especially-strong leadership teams able to unravel

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

2
their firms’ competitive situations, formulate effective business strategies, and

successfully implement these strategies. Not surprisingly, the stocks of these most-

admired companies have proven to be extremely good investments.3 Second, there

are two points of major discontinuity in the table: the first appearing in the latter-

years of the 1990s, and the second in the latter-years of the 2000s. These two

points-of-discontinuity reflect two substantive business disruptions.

Table 1-1
Most Admired Companies: 1983-2016

Rank
Years
1 2 3 4 5
2014-2016 Apple Google Amazon Berkshire Hathawaya Walt Disney
2011-2013 Apple Google Amazon Coca Cola Berkshire Hathaway
2008-2010 Apple Google Berkshire Hathaway Toyota Motors Johnson & Johnson
2005-2007 General Electric Starbucks Southwest Airlines FedEx Berkshire Hathaway
2002-2004 Walmart Southwest Airlines General Electric Berkshire Hathaway Microsoft
Cisco Systems
1999-2001 General Electric Microsoft Walmart Dell
Southwest Airlines
1996-1998 Coca Cola Microsoft Intel Merck Johnson & Johnson
3M
1993-1995 Rubbermaid Coca Cola Home Depot
Microsoft
1990-1992 Merck Rubbermaid Walmart Proctor & Gamble PepsiCo
Boeing
1987-1989 Merck Rubbermaid Liz Claiborne 3M
Phillip Morris
1983-1986 IBM Dow Jones HP Merck Coca Cola

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

Significant business disruptions occur when an industry’s incumbents face

one or more challengers whose business models offer far greater value to customers

than the incumbents’ business models and these incumbents are unable to effectively

respond to the ensuing competitive threat. A key element in this definition is that of

J. Anderson and G. Smith, “A Great Company Can Be a Great investment,” Financial

3

Analysts Journal, July/August 2006, pp. 86-93).

3
a business model – a simplified and aggregated conceptualization of the value-

creating, profitability-sustaining activities of an organization. Importantly, not all

business innovations are disruptive. A business innovation that is compatible with

an industry’s established business models generally creates short-term benefits (i.e.,

revenue and profitability gains) for the innovating firm, and long-term benefits (i.e.,

the exposure of previously-uncontested competitive niches) for all incumbents.

The two points-of-discontinuity noted above in Table 1-1 reflect periods of

digital disruption, where (1) incumbents in existing industries faced overwhelming

competitive challenges, and (2) entirely new industries (e.g., Internet sales channel,

Internet search) were created. Two forces explain much of this digital disruption:

unceasing advances in digital technologies and globalization.

Digital technologies refer to the many technologies (encompassing

hardware, software and, most often, sophisticated combinations of hardware and

software) involved in specifying, capturing, processing, storing and transmitting data.

Here, data refers to attributes of objects or events represented in digital (discrete

sets of ones and zeroes) form. Through hardware and software innovations

(especially those associated with microprocessor miniaturization), digital

technologies have experienced sustained, exponential growth in performance relative

to cost. Popularly referred to as Moore’s Law, the capability per dollar of digital

technologies essentially doubles each year – enabling an unending stream of new

technological possibilities. Importantly, these technological innovations yield new

digitally-enabled, value-creating functionalities (e.g., Amazon’s digital ordering

process and fulfillment processes), which can be creatively recombined to produce

new functionalities (e.g., Amazon’s 1-Click ordering process), and so on. It is the

4
confluence of such streams of innovative functionalities that periodically drive truly

substantive business disruptions. Today, five technologies represent the tip of the

spear of digital disruption – social, mobile, analytics, cloud, and the Internet of

Things.

Globalization refers to a process of interaction and, especially, integration

among the people, companies and governments of different nations. The

extraordinary advances in digital technologies have broken through well-established

barriers of space and time, ushering in a largely irreversible globalization of business

characterized by vast streams of data (and information) endlessly moving around the

world. As a consequence, firms are rethinking what it means to be global.

Digitally-enabled globalization is requiring established companies to reinvent

themselves in order to: leverage global capabilities, present a common face to global

customers, and compete with digital startups. Prime examples of such globalized

firms are those providing logistics services (UPS and DHL) and technology services

(IBM and Infosys). As economic activity accommodates emerging markets and

refocuses on local communities, new competitive spaces arise – such as firms focused

on meeting consumers’ localized needs regarding travel information (TripAdvisor and

Feefo), temporary asset use (Airbnb and Zipcar), and personalized services (Uber

and TaskRabbit).

In essence, the mind-set that digital technologies primarily represent a

productivity-enhancing tool is being replaced with a new mindset that recognizes

digital technologies as a platform for strategic innovation, transformation and

disruption. Consider, for example, the fintech revolution – the disruptions currently

5
affecting financial services.4,5 The business models of retail banks have traditionally

sought to meet all of their customers’ financial needs. Here, low-cost checking

accounts serve as ‘loss leaders’ to earn attractive margins in other areas (e.g., home

mortgages, car loans, credit cards, investment management, etc.).

Recently, new entrants to the financial services industry seek to exploit

technological advances along with shifts in consumer behavior gravitating toward

self-service and digitally-enabled transaction channels. They are finding success in

weakening and dismantling the relationships that retail banks have developed over

the years with their customers. Typically, these challengers (startups, established

digital banks, and established firms holding strong, broad-based digital capabilities)

target the more-profitable segments of retail banking, making it clear that they have

little interest (at least for now) in handling all of a person’s banking needs. The

people most attracted to these fintech challengers are millennials, small businesses,

and the underbanked – retail banking customer segments particularly sensitive to

costs and to the enhanced consumer experience provided through digital transaction

channels.

The first wave of the fintech revolution focused on payment transactions (e.g.,

PayPal and Square), which represents about six percent of global banking

transactions. The next waves seem to be converging on retail lending (roughly twelve

percent of global banking transactions, e.g., Affirm and SoFi) and retail

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

4
G. Bacso, M. Dietz and M. Radnai, “Decoding Financial-Technology Innovation,”
McKinsey Quarterly, Number 2, 2015, pp. 26-27).
5
M. Dietz, P. Härle and S. Khanna, “A Digital Crack in Banking’s Business Model,”
McKinsey Quarterly, Number 2, 2016, pp. 50-53.
6
disruptive business innovations improve on how incumbent retail banks do business

and are ripe for imitation. Taken together, these financial services innovations are

forcing a reinvention of what it means to be a retail bank.

Most of today’s fintechs, which number in the thousands globally, remain under

the regulatory radar but are quickly attracting attention as they reach meaningful

scale. Why all this entrepreneurial activity? Simply put, the potential rewards are

enormous. Capturing just a tiny slice of the $1 trillion global retail banking market

can deliver very attractive returns for owners and investors.

This ongoing disruption of the financial services industry is not an isolated

exception. Digital competitors are entering all industries, creating a need for

strategic responses by established businesses and by the early new entrants. At the

same time, an organization’s digitally-enabled operational business processes have

become mission critical. There is no room for operational errors, even as

organizations strive to increase their pace of digital innovation.

The objective of this book is to depict how today’s exemplar organizations set

and evolve their digitally-enabled business strategies, or stated more directly – their

digital strategies. In this chapter, we begin this conversation by introducing three

key notions:

 The Evolving Nature of Markets and Firms

 Three Eras of Digital Disruption

 The Evolving Landscapes of Industries

The Evolving Nature of Markets and Firms

Markets and firms are historically regarded as significant mechanisms for the

organization of economic activities. Economic exchanges in a market occurs

7
primarily through pricing mechanisms and contractual mechanisms, whereas

economic exchanges within a firm occurs primarily through hierarchical structures

and control structures. Discrete market exchanges can occur between two people

(C2C, or consumer-to-consumer), two organizations (B2B, or business-to-

business) or between an organization and a person (B2C, or business-to-

consumer). Successful markets bring two parties together such that each party is

confident that the exchange will be evenhanded; that is, one party, the consumer,

receives a sought value-unit at a fair price and the other party, the producer, receives

fair compensation for delivering this value-unit to the consumer.

Successful markets are characterized by three key attributes:

 Demand exists for the value-units being exchanged.

 The market is profitable.

 The market is efficient.

An efficient market exists when maximal opportunities are provided to producers

and consumers to effect transactions with minimal transaction costs. Inefficient

markets are susceptible to market failure, with four conditions explaining a

preponderance of market failures:

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

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

 One or more third-parties not directly involved in an exchange or in

facilitating the exchange benefit from the exchange, e.g., a ‘kickback’.

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

8
 other party.

When one or more of these conditions are present, the likelihood of market

participation decreases and the likelihood of participant dissatisfaction increases.

As the value-units being exchanged increased in complexity and sophistication

as a result of the first (specialized machinery and economies of scale) and second

(railroads and telecommunication) industrial revolutions, firms emerged as an

alternative to markets. Viewed simply, a firm (or, an organization) consists of a

set of operating units coordinated and integrated by a hierarchy of managers,

supported by other employees – all of which are located within an overarching

organizational structure. Each operating unit itself has managers and workers

engaged in specialized economic activities. And, the firm as a whole interacts with

customers and suppliers within a market-focused ecosystem that, typically, engages

multiple markets for goods and services.

Today, the distinctions between markets and firms are blurred via the

emergence of two distinctive, market-focused ecosystems: the pipeline ecosystem

and the network ecosystem.

With the pipeline ecosystem (the dominant ecosystem over the last century;

depicted as Figure 1-1), a producer organization targets a collection of value-units at

one or more consumer segments and fashions a linear value stream involving

numerous upstream (e.g., raw material suppliers, component suppliers, etc.),

midstream (e.g., producers) and downstream (e.g., distributors, retailers, etc.)

organizations to deliver the value-units to consumers. This ecosystem is referred to

as a linear value stream because it involves a sequence of value-adding steps: raw

materials are assembled first into components and then into finished value-units

9
(information, a good or a service) that are delivered to consumers, either through a

complex downstream process facilitated by intermediaries or through a simpler,

direct-to-consumer downstream process. These value-stream steps are often

performed by different organizations (exploiting specialization), but may all be

performed by the producer; such a producer is referred to as being fully vertically-

integrated.

Figure 1-1
The Pipeline Ecosystem

Upstream Midstream Downstream

Material &
Component Intermediaries Producer Intermediaries Consumers
Suppliers

Markets
Markets

The producer organization in a pipeline ecosystem has:

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

 Full authority for fashioning and overseeing the linear value stream.

 Full ownership of the assets used in assembling the finished value-units, as

well as the assets used in any vertically-integrated portions of the linear
value chain.

10
The primary market defining a pipeline ecosystem is that between the producer and

the consumer. In a B2C pipeline ecosystem, the predominant consumer is an

individual. In a B2B pipeline ecosystem, the predominant consumer is an

organization. In addition, a variety of secondary markets (usually B2B markets for

raw materials, for component parts, for products to stock a retail store, etc.) are

associated with pipeline ecosystems.

With the network ecosystem (an ecosystem that has become increasingly

visible over the last decade; depicted as Figure 1-2), a network of value-unit

producers and value-unit consumers are brought together by a network orchestrator.

The primary market defining a network ecosystem involves value-unit exchanges

between producers and consumers. The network orchestrator creates and

manages the market environment and the transaction environment within which

these value-unit exchanges occur. Importantly, the network orchestrator neither

determines the nature of the value-units being exchanged nor owns any of the assets

involved in producing these value-units.

11
 Figure 1-2
The Network Ecosystem

Upstream Midstream Downstream

Material &
Producer Network Consumer
Component Intermediaries
Network Orchestrator Network
Suppliers

Markets Markets

Market

What is the difference between a retailer, such as Walmart, and a network

orchestrator, such as eBay? Doesn’t Walmart create a market environment (a retail

store with a finely curated stock of products) within which producers and consumers

are brought together? The difference is that:

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

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

As a consequence, Walmart represents a pipeline organization, whereas eBay

represents a network organization.

12
 Digital disruption is having profound effects on the roles that humans serve in

market-focused ecosystems, especially as employees of participating organizations.

Digital technologies and humans differ markedly in the types of work tasks each best

handles, and Table 1-2 suggests the probability of different types of work tasks being

performed digitally rather than being performed by humans.

Table 1-2
Probability of Work Tasks Being Performed Digitally

Type
Definition Probability
of Work
Acquiring new knowledge by interpreting & Lower
Learning
integrating captured data and experiences

Situational
Interpreting environmental & situational cues
Awareness

Word/Image Interpreting the meaning of words (textual &

Analysis audio) and images (sketches, photos & video)

Numerical
Performing complex algorithmic operations
Analysis

Repetitive Programming robot-like digitalized solutions to

Physical Activity carry-out simple & complex physical tasks

Repetitive Programming software to carry-out simple &

Data Processing complex data processing tasks Higher

Digital solutions are especially good for executing pre-specified rules, but not

as effective at pattern recognition, complex communication, and creativity – types of

activities that well-informed, talented humans can be exceptional at performing. For

example, think about how important it is during a brainstorming session to quickly

filter out bad ideas, but recognize and enhance the good ideas. It is hard to conceive

that a digital solution could outperform a human with such a work task. Still, the

relentless advances in digital technologies are making significant headway with the

digital enablement of work tasks requiring considerable levels of situational

understanding and prediction. Perhaps the best that can be said for now is that the

13
roles served by digital technologies and by humans in innovative business models

are in flux and will certainly continue to evolve in the future.

Three Eras of Digital Disruption

Figure 1-3 presents timelines for three eras of digital disruption. These eras

reflect the influence of increasing digitization and increasing digitalization.

Digitization refers to the purely technical processes associated with converting

sensed and captured data into binary form, storing and transmitting these binary

data, manipulating these data, and storing/transmitting the outcomes of these data

manipulations. Digitalization, on the other hand, refers to more complex processes

of applying digitization within organizations and within the social and economic

contexts within which organizations are embedded – thence producing changes (often

incremental, but occasionally radical and disruptive) to these organizations and to

their social and economic contexts.

Figure 1-3
Three Eras of Digital Disruption

1950 1960 1970 1980 1990 2000 2010 2200

Data Processing & Proprietary Connectivity

Era 1

Coordination & Open Connectivity

Era 2

Mobility & Ubiquitous

Connectivity

Era 3

14
 The start date for each of the three eras is, at best, an approximation. While

it is fairly easy to identify when a specific digital technology first appeared, it is very

difficult to identify when novel instances of digitalization are applied by early-

adopters. Early-adopters refer to organizations whose leadership teams are

regularly among the first to apply new forms of digitalization. It takes time for early-

adopters to learn about and expose the usefulness of new forms of digitalization and

for these exposed uses to take root across organizations, industries and societies.

While some early-adopters may experience huge competitive gains from their

innovative actions, a greater number experience little gain or suffer losses because

innovative actions tend to be costly and often prove to be ill-founded or ill-timed.

It is important to note that the lapse in time between the start of an era and

when implementations of new forms of digitalization consistently yield significant

value for adopters shortened considerably between the first and second eras, and is

expected to shorten even further between the second and third eras. There are a

number of possible explanations as to why this is the case, and these will be raised

throughout this book. One of these reasons is that the forms of digitalization

emerging in one era, e.g., Era 1, become pervasively adopted over time and are

continuously enhanced, thus providing an ever-expanding digitalization foundation

that is leveraged as newer forms of digitalization emerge in succeeding eras, e.g.,

Eras 2 and 3.

New forms of digitalization are rendered through four engines of digitalization

(i.e., automation, control, empowerment and interaction), and applied within three

domains of digitalization (i.e., operational, analytical and collaborative). The

engines of digitalization refer to four fundamental mechanisms through which

15
digital technologies effect changes within organizations and their broader

social/economic contexts. The domains of digitalization refer to three

fundamental spheres of organizational activity within which digitalization occurs.

The four engines of digitalization (automation, control, empowerment, and

interaction) operate individually or in combination in fabricating new forms of

digitalization. Definitions of and examples of the benefits to be obtained from

applying these digitalization engines are provided in Table 1-3.

Table 1-3
Four Engines of Digitalization

Digitalization
Definition Examples of Realized Benefits
Engine
Simplifying & digitalizing complex tasks
•Cost reduction.
& task-sequences, eliminating unneeded
•Transaction cycle-time improvement.
Automation tasks, and, as appropriate, performing
•Responsiveness improvement.
tasks via digitalization rather than via
•Productivity improvement.
humans.
Embedding digitalized rules to identify
•Real-time event/situation monitoring.
out-of-control events/situations, such
•Real-time event/situation visibility.
Control that out-of-control events/situations
•Minimizing the occurrence of inferior decisions
either do not occur or, if they do occur,
& inferior actions.
are quickly addressed.
Providing humans facing decisions with
•Broad distribution of and access to data,
timely, accurate & comprehensive
information & knowledge.
Empowerment information and with easy-to-use,
•Broad availability of & access to decision aids &
relevant decision aids & business
business intelligence tools.
intelligence tools.
•Complex & non-routine business activities
Enabling humans, digitalized solutions or
handled quicker & better .
both to engage in timely, meaningful
Interaction dialogues (overcoming barriers of space
•Problems & opportunities handled quicker &
better.
and time).
•Innovative activities handled quicker & better.

The three digitalization domains (operational, analytical, and

collaborative) are best seen as being complementary. In other words, a specific

digitalization initiative might target, within a specific entity (i.e., one or more of an

organization’s subunits, the entire organization, subunits of a set of cooperating

organizations, etc.): a single domain, two of the three domains or all three of the

16
domains. Definitions of and examples of the benefits to be obtained within each

domain from digitalization are provided in Table 1-4.

Table 1-4
Three Domains of Digitalization

Digitalization
Definition Examples of Realized Benefits
Domains
Organizational activities involved in
•Enhanced task effectiveness
getting tasks done. The entities
(accuracy, comprehensiveness,
engaged in task-related activities could
timeliness, convenience, etc.)
Operational include digitalized solutions, humans,
•Enhanced task efficiency
teams, organizational subunits,
(productivity, cost, error, rework,
organizations and/or sets of
etc.)
collaborating organizations.
Organizational activities involved in •Enhanced decision effectiveness
improving understandings of what (accuracy, comprehensiveness,
things should be done, what things timeliness, convenience, etc.)
Analytical
need to be done, what things can be •Enhanced decision efficiency
done, how things are done, and how (productivity, cost, error, rework,
what has been done is assessed. etc.)
Organizational activities involved in
enabling digitalized solutions, humans •Enhanced task effectiveness
and/or organizational entities to share •Enhanced task efficiency
Collaborative
data, information & knowledge and to •Enhanced decision effectiveness
cooperate in making decisions and in •Enhanced decision efficiency
getting things done.

Table 1-5 presents an overview of the key features of each of the three eras

of digital disruption. A few aspects of this table would benefit from a brief introduction

before each of the eras is described. First, an architecture refers to an overarching

design framework specified to (1) maintain established policies, e.g., all digitalized

transaction-handling should make use of a common database, and (2) enable

component interoperability, e.g., all business applications should operate through the

use of an agreed-on set of communications devices. When two or more digital

solutions are interoperable, these solutions are able to seamlessly exchange data

and able to apply these exchanged data. Second, digital technologies can be

proprietary or open. Stated simply, a proprietary technology is tightly controlled

by its developer, while an open technology is available for use (and for modification)

17
by anyone (though some form of payment may be required to gain access to the

technology). Third, the lower part of the table illustrates the relative extent to which

each era exploited the four engines of digitalization. As can be seen below, while

digitalization in Era 1 focused on automation and control, Era 3 digitalization is

characterized by high levels of each of the digitalization engines.

Table 1-5
An Overview of the Three Eras of Digital Disruption

Era 1 Era 2 Era 3

• Data Processing • Coordination • Mobility
• Proprietary Connectivity • Open Connectivity • Ubiquitous Connectivity
Key Digital Computer systems, remote Personal computers, servers, Smart personal devices,
Technologies terminals, networks, database ERP systems, analytics social technologies,
management, packaged
software, World Wide Web Internet of Things, Big Data
software
Digitization
Centralized Distributed Ubiquitous
Architecture
Connectivity One-to-Many One-to-Many Many-to-Many Many-to-Many
Architecture Proprietary Open Proprietary Open
Digitalization
Transaction Handling Decision/Action Coordination Value-Unit Enhancement
Architecture
Digitalization
Efficiency Optimization Community-Building
Purpose
Digitalization Engines
Automation
Control
Empowerment
Interaction

Organizations recognized as digitalization leaders during Era 1 emphasized

automation and control, driving growth and profitability through heightened

efficiency. During this era, most typically, digitization was centralized, connectivity

accentuated establishing proprietary links with preferred suppliers/customers, and

digitalization focused on the handling of transactional data and the use of these data

in supporting operational decisions and actions. Table 1-6 provides a brief glimpse

18
of innovative initiatives introduced by two Era 1 disruptors: American Airlines and

Merrill Lynch.

Table 1-6
Era 1: Innovative Digitalization Initiatives

American Airlines Merrill Lynch

Sabre Reservation System Cash Management Account
Digitalization Realized Benefits Digitalization Realized Benefits
Enabled travel agents to book
Common
passenger flights with greater Integrated database Offered business
database of
efficiency, speed & flexibility. of all of a business customers a financial
current flights,
In this booking process, customer’s accounts management service for
routes & pricing
American used the system to (e.g., savings, maintaining a desired
offered by
display its own flights before checking, brokerage). level of liquidity while
multiple airlines.
other airlines’ flights, sweeping daily excess
increasing American’s Digitalized decision- cash into higher-yield
Desktop-based
bookings. making system brokerage accounts.
software
enabling a business
allowing travel
Other airlines paid a fee to customer to log onto The digitalized decision-
agents to dial-in
American for the ability to list their Cash making system
to the Sabre
their flights and an even Management Account monitored market
System to
higher fee for a priority listing. to track investment conditions and executed
search for flights
opportunities and to customer-initiated
& prices and to
American gained valuable execute account- actions across a
make direct
intelligence about related actions. customer’s accounts.
bookings.
competitors’ prices & routes.

Organizations recognized as digitalization leaders during Era 2 continued

emphasizing automation and control, but also made significant headway with

empowerment (via Enterprise Resource Planning systems and business analytics) and

interaction (via the open connectivity offered by the technologies that underlay the

World Wide Web), further boosting growth and profitability by tightly coordinating

decisions and actions. Typically, digitalization was distributed across centralized and

localized sites, connectivity proliferated across value-stream participants via open

one-to-many connections (B2C e-commerce) and proprietary many-to-many

connections (B2B), and digitalization focused on coordinating operational and tactical

decisions and actions both within and across organizations’ boundaries. Table 1-7

19
provides a brief glimpse of innovative initiatives introduced by two Era 2 disruptors:

United Parcel Service (UPS) and Boeing.

Table 1-7
Era 2: Innovative Digitalization Initiatives

United Parcel Service (UPS) Boeing

Package Flow System 777 Parts Tracking System
Digitalization Realized Benefits Digitalization Realized Benefits
Smart (bar-coded)
Parts delivery
labels are placed
processes from
on packages,
suppliers to Boeing
providing detailed Loads are balanced across
capture real-time
delivery trucks, drivers & routes. Costs are better
data (across the
information. contained (delivery,
globe) on movement,
Routes are optimized to inventory, assembly)
route location,
Once a package increase efficiency & while handling over 3
weather conditions
arrives at a effectiveness. million parts from over
and road conditions.
Delivery Center, 500 (domestic &
truck loading Drivers are able to speed up international) suppliers.
Parts delivery
plans and delivery deliveries and to make more
processes are
routes are deliveries on a route. Parts arrive as they are
coordinated &
optimized. needed in the assembly
optimized (part
process.
manufacturing lead
Route details are
times, modes of
sent to drivers’
transport, delivery
hand-held
routes).
devices.

Organizations recognized as digitalization leaders during Era 3 emphasize all

four engines of digitalization: automation, control, empowerment and interaction.

Especially important for heightened empowerment and heightened interaction is the

mobility and ubiquitous connectivity offered through the convergence of smart

personal devices (e.g., smartphones and tablets), the Internet of Things

(miniaturized microcircuitry embedded within all types of products), and the

advanced analytics made possible through Big Data (streams of digital data created

via the real-time capture of messages and events). Along with new efficiency and

optimization opportunities, growth and profitability are being spurred through the

active formation and mobilization of the stakeholder-communities (e.g., material and

component suppliers, services providers, producers, retailers, and/or consumers)

20
that comprise market-focused ecosystems. Today, digitization and digitalization are

both on the verge of being ubiquitous, connectivity is increasingly many-to-many and

open, and digitalization focuses on value-unit (e.g., products, services, and/or

information) enhancement. Table 1-8 provides a brief glimpse of innovative

initiatives introduced by two Era 3 disruptors: LEGO6 and Airbnb.

Table 1-8
Era 3: Innovative Digitalization Initiatives

LEGO Airbnb
LEGO Ideas Community Center
Digitalization Realized Benefits Digitalization Realized Benefits
Thousands of fresh and
A digitally-enabled A digitally-enabled
innovative ideas are
open community community of Airbnb
proposed for new LEGO
where LEGO fans: hosts where ideas & A relatively low cost
sets.
propose ideas for advice are exchanged, mechanism for:
new LEGO sets thus easing the effort• Educating & supporting
LEGO sets obtaining 10,000
(using existing taken by participants new hosts.
or more votes are likely to
LEGO bricks), in learning how to • Establishing & evolving
be market successes.
review proposed succeed as a host. a desired culture across
ideas, and vote on the host community.
Since 2014, nine new LEGO
proposed ideas. Topics are • Building enthusiasm &
sets have evolved from the
personalized to a comradery across the
LEGO Ideas program.
Ideas receiving host’s language and host community.
10,000 votes country, hot topics • Mobilizing local host-
The interactions occurring
within a year are are promoted, and top communities’ face-to-
across the fan community
moved into LEGO’s contributors are face sharing and
(as ideas are reviewed &
product listed. political action.
actively supported)
development
provides essentially free
process.
promotion for LEGO.

Revisiting Fortune’s Most Admired Companies

Table 1-9 revisits our synthesis of Fortune’s annual listing of the most admired

companies. Now, however, many of the table cells are color-coded:

 Red – digital technology product/service providers

 Blue – Era 1 organizations listed multiple times

O. El Sawy, H. Amsinck, P. Kraemmergaard and A.L. Vinther, “How LEGO Built the
6

Foundations and Enterprise Capabilities for Digital Leadership,” MIS Quarterly Executive, June
2016, pp. 141-166.
21
  Orange – Era 2 organizations listed multiple times

 Green – Era 3 organizations listed multiple times

Two key insights about successful digital strategizing can be gleaned from this table.

Table 1-9
Revisiting Fortune’s Most Admired Companies

Rank
Years
1 2 3 4 5
2014-2016 Apple Google Amazon Berkshire Hathaway Walt Disney
2011-2013 Apple Google Amazon Coca Cola Berkshire Hathaway
Berkshire
2008-2010 Apple Google Toyota Motors Johnson & Johnson
Hathaway
General
2005-2007 Starbucks Southwest Airlines FedEx Berkshire Hathaway
Electric
Southwest
2002-2004 Walmart General Electric Berkshire Hathaway Microsoft
Airlines
Cisco Systems
General Dell
1999-2001 Microsoft Walmart
Electric
Southwest Airlines
1996-1998 Coca Cola Microsoft Intel Merck Johnson & Johnson
3M
1993-1995 Rubbermaid Coca Cola Home Depot
Microsoft
1990-1992 Merck Rubbermaid Walmart Proctor & Gamble PepsiCo
Boeing
1987-1989 Merck Rubbermaid Liz Claiborne 3M
Phillip Morris
1983-1986 IBM Dow Jones HP Merck Coca Cola

First, the highlighted companies in Eras 1 and 2 all represent pipeline

organizations, aside from Berkshire Hathaway.7 In Era 3, however, the highlighted

firms (again, aside from Berkshire Hathaway), represent a pure network

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

General consensus suggests that Berkshire Hathaway’s success as a holding company

7

rests on three factors: acquiring exceptionally well-run businesses, retaining these

businesses’ existing leadership teams and allowing these leaders considerable autonomy to
run their business, and moving slack financial resources across these businesses to take
advantage of temporal and sectoral opportunities.
22
Blended organizations operate both as pipeline organizations and as network

organizations:

 Apple produces consumer-oriented technology products via tightly-managed

value streams and orchestrates iTunes and Apple Music, markets that bring
together communities of music producers and music consumers.

 Amazon manages a pipeline-like B2C e-commerce business and orchestrates

consumer and business marketplaces, bringing together communities of
sellers and consumers.

We anticipate that organizations’ digital strategies will increasingly incorporate

elements of both pipeline organizations and network organizations.

Second, highlighted organizations in Eras 1 and 2 include technology-

producing firms and technology-using firms. Era 3, however, lacks pure technology-

producing firms. Instead, Apple, Google and Amazon are both producing (alone and

with strategic partners) advanced digital technologies and introducing streams of

digitalization innovations. Additionally, Google and Amazon are technology services

providers. Interestingly, the highlighted Era 2 organizations, i.e., General Electric,

Southwest Airlines and Walmart, were noted for their large and superb technology

groups that, alone and with strategic partners, introduced streams of digitalization

innovations. We anticipate that organizations’ digital strategies will increasingly

incorporate homegrown digitalization innovations.

The Evolving Landscapes of Industries

The constant threat of digital disruption places organizations’ leadership teams

in increasingly hostile and competitive environments. A variety of competitors exist

(nimble digital startups, established companies with strong market positions and

well-honed operational processes, and everything in-between) across all industry

23
sectors. N. Venkatraman8 provides a framework for understanding the industry

forces now at play by identifying the three sets of influential competitors that are

active in most industries today:

 Incumbents: These are firms who have been traditionally operating in an

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

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

 Technology Entrepreneurs: These firms are younger or smaller firms that

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

Industry strategic landscapes today must be seen as being populated by not only

incumbents, but also by digital giants and technology entrepreneurs. As a

consequence, digital strategists within today’s emerging market-focused ecosystems

must weave together the interests and capabilities held by incumbents, digital giants

and technology entrepreneurs in fashioning the business models most likely to

produce competitive success.

A Recap and Look Ahead

Conventional notions about competitive strategy are being challenged with the

power of digital technologies to provide the means for innovation, organization

N. Venkatraman, The Digital Matrix: New Rules for Business Transformation through
8

Technology, Life Tree Media, 2017.

24
transformation, and market disruption. As firms across all industries are feeling the

heat, it is imperative that fresh ways of thinking are surfaced about the nature of

competition and about what is needed to achieve competitive success. The next

chapter provides insights regarding these fundamental ideas that underlay effective

digital strategies.

25
 Chapter 2. Digital Strategy Fundamentals

How should firms master the challenges and opportunities of digital innovation

and disruption? What types of models and mindsets will help managers effectively

lead their organizations in today’s digital economy? The following three sets of

fundamental ideas regarding digital strategy are described in this chapter:

 The Goal of Digital Strategy: Agility

 The Grammar of Digital Strategy: Business Models

 The Logic of Digital Strategy: Competitive Moves

The Goal of Digital Strategy: Agility

In modern competitive arenas, the pursuit of sustained competitive advantage

is an illusion because of the tremendous disruptive pressures facing firms and

industries. Therefore, the hallmark of a successful digital strategy is succinctly

described via the concept of agility. Agility is a firm’s ability to detect potentially

disruptive threats and opportunities and, then, to marshal the resources and

managerial insights required to subdue threats and/or exploit opportunities. Agility

addresses two seemingly contradictory objectives: achieving stability, i.e., the

ability to withstand disruptions by maintaining operational reliability and efficiency;

and, achieving dynamism, i.e., the ability to innovate, transform and disrupt by

demonstrating strategic adaptability, speed and entrepreneurism. In essence, agility

requires organizations to execute a portfolio of business models that simultaneously

account for two aims – ensuring stability in currently-executing operational processes

(so as to meet stakeholders’ expectations and competitors’ performance levels), and

ensuring an ongoing stream of well-founded, future-oriented competitive actions.

26
This duality is reflected in the need for competitively-successful organizations to

exhibit two forms of agility. Adaptive agility refers to the ability to aggressively

introduce incremental enhancements into currently-executing business models,

whereas entrepreneurial agility refers to the ability to aggressively introduce

radical enhancements into currently-executing business models or to introduce new

business models.

Adaptive and entrepreneurial agilities are important because the only sure

thing that can be said about today’s market ecosystems is that they are highly

uncertain as a consequence of:

 Finely-tuned and highly-differentiated consumers.

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

 The regular appearance of new entrants (startups, established players from

adjacent markets, digital giants, technology entrepreneurs).

 The periodic restructuring of value-streams and participants’ relative

influence within market-focused ecosystems.

To paraphrase Project Runway’s Heidi Klum: one day you’re in and the next day

you’re out. Extending, or even maintaining, a strong competitive position demands

a continual stream of well-targeted competitive actions.

Therefore, organizations’ digital strategies are unlikely to take the form of

methodically-stipulated, lengthy (over a two- or three-year planning horizon) and

tightly-coordinated series of competitive actions. Instead, organizations’ competitive

actions are most likely to occur opportunistically or reactively, but in accordance with

a strategic intent that establishes strategic direction and strategic purpose. A

strategic intent directs digital strategists’ thought processes as competitive moves

are formulated and implemented – without dampening the flexibility and autonomy

27
necessary and adaptive/entrepreneurial agilities. A broadly-communicated strategic

intent focuses strategists’ opportunity-seeking, thereby exerting a dominant

influence on the formulation of competitive moves (see Figure 2-1). Even though

organizations’ strategic intents do evolve, they serve the critically important role of

ensuring that organizations’ investments in digital resources are guided in a

consistent fashion across time – increasing the likelihood that new investments

leverage and complement in-place resources.

Figure 2-1
The Influence of Strategic Intents on Competitive Moves

Competitive Moves

Digital Strategists’
Strategic Knowledge,
Intent Perspectives & Business Model
Insights Enhancement,
Replication &
Innovation

Competitive Outcomes

A strategic intent is derived from the knowledge, perspectives and insights

held by digital strategists. In envisioning and evolving a strategic intent, an

organization’s digital strategists are especially influenced by their understanding of

the core capabilities that underlie the value propositions expected to most appeal to

consumers and the extent to which their organization has digitalized these

capabilities – key underpinnings of a business model.

28
The Grammar of Digital Strategy: Business Models

Business models reflect the choices made by organizations’ leadership teams

about how value is created and how profitability is realized. As shown in Figure 2-2,

there are four distinct elements of agile business models:

 A value proposition defines how an organization will distinguish itself

within the market(s) that it has chosen to participate. Pipeline organizations
distinguish themselves by creating value for consumers. Network
organizations distinguish themselves by creating value for participating
communities.

 A profit model consists of revenue and cost models. Revenue models

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

 Core capabilities refer to the tangible resources (e.g., facilities, machinery,

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

 Dynamic capabilities refer to the intangible resources (e.g., people,

knowledge, relationships, managerial processes, architectures, etc.) needed
to (1) sense and assess opportunities for business model enhancement,
replication and innovation, and (2) successfully implement these
enhancements, replications and innovations.

Figures 2-3 and 2-4, respectively illustrate each of these elements via portraits of

agile business models reflective of Apple’s participation in the consumer smart device

market and Walmart's participation in the retail market.

29
 Figure 2-2
Elements of an Agile Business Model
•What is the value-unit?
•Who is the consumer?
•What does the consumer desire
and expect with regard to this
value-unit?
Value
Proposition
Core Dynamic
Capabilities Capabilities
What are the resources & activities
critical to providing consumers
with a value-unit they value and to
do so in a profitable manner?
Figure 2-3
Apple’s Business Model for the Consumer Smart Device Market
• Value-unit: Consumer smart digital devices
• Consumer: Technically-receptive &
technically-savvy segments of the personal
smart device market
• Innovative & trend-setting products
• Seamless access to content across all digital
media
Value
Proposition
Core
Capabilities
• Brand management
• Technology patents
• Product design & product architecture design
• Tightly-directed sales & marketing
• Tightly-controlled manufacturing & logistics,
performed by third-parties
• Relationships with content providers and
with manufacturing & logistics partners
•How is revenue generated?
•What is the cost structure?
•How is profit created?
Profit
Model
What are the resources & activities
critical to ensuring that well-founded
business model enhancements,
replications & innovations are
undertaken to maintain competitive
positions within the markets we
participate and the new markets we
enter?
• High product prices driven by stimulating
demand and by limiting supply
• Moderate manufacturing & marketing costs
• High margins
Profit Model
Dynamic
Capabilities
• Knowledge of new digital technologies
• Knowledge of evolving desires of first-
adopter consumers
• Knowledge of new digital media and of new
means for accessing digital media
• Knowledge of product designers & architects
• Knowledge of content management
architects
30
 Figure 2-4
Walmart’s Business Model for the Retail Market

• Value-unit: Household groceries &

products
• Consumer: Cost-sensitive segment of the • Low prices, low costs
mass market • Moderate margin
• ‘Everyday Low Prices’ • High volume, high product
• Retail store availability of a broad range turnover
of products, enabling one-stop shopping

Value Profit Model

Proposition

Core
Capabilities Capabilities
• Store site selection & store layout design
• Tailor local inventory to local market
• Shelf-space optimization (merchandizing &
replenishment)
• Logistics optimization
• Supplier relationships
Dynamic
• Knowledge of new digital technologies
• Knowledge of evolving shopping-experience
desires of mass-market consumers
• Knowledge of digitalization trends &
innovations in retail-store operations and in
logistics
• Logistics designers & technologists
• Retail store designers & technologists

Value disciplines are a fundamental element of business models and align

the value propositions with the expectations of their consumers.9 Some types of

consumers seek low prices, quality and convenience; organizations pursuing this

consumer adopt the operational excellence value discipline. Other consumers are

more concerned with having their needs and preferences met fully and are willing to

pay a premium for this to occur; organizations pursuing this consumer adopt a

customer intimacy value discipline. Finally, some consumers seek the state-of-

the-art, the trendy and/or the stylish and are willing to pay a premium for this to

occur; organizations pursuing this customer adopt a product leadership value

9
M. Treacy and F. Wiersema, “Customer Intimacy and other Value Disciplines,”
Harvard Business Review, January-February 1993, pp. 84-93.
31
discipline. Table 2-1 summarizes the value propositions and core capabilities

associated with each of the value disciplines.

Table 2-1
The Three Value Disciplines

Value
Value Proposition Core Capabilities Examples
Discipline

 Manufacturing, assembly and/or

Amazon
 Quality, low-cost value- merchandising
Dell
Operational unit  Order processing & fulfillment
General Electric
Excellence  Reliable, convenient  Inventory management
FedEx
delivery process  Upstream/downstream logistics
Walmart

Amazon
• Micro-segmentation
 Tailored value-unit Google
Customer • Consumer relationship management
 Tailored delivery Harrah’s
Intimacy process
• Advertising & marketing
Kraft Foods
• Campaign management
Ritz Carlton
 State-of-the-art, trendy
and/or stylish value- 3M
 Research & development
units Apple
Product  Rapid commercialization
Intel
Leadership  State-of-the-art, trendy
 Quality assurance
Merck
 After-sales support
and/or stylish delivery Johnson & Johnson
process

General Electric (GE): Operational Excellence in Action

GE’s consumer appliance business10 adopted the operational excellence value

discipline in the 1980s by introducing the Direct Connect initiative to become a low-

cost, hassle-free supplier to appliance dealers. Historically, the company fully loaded

its dealers – that is, it expected dealers to stock full inventories of appliances by

incentivizing them to purchase full truckloads. This strategy lost favor when the

independent dealers began to face severe competition from lower-priced, multi-brand

chains such as Best Buy.

10
As part of their Industrial Internet business strategy, GE sold their appliance
business to Qingdao Haier in 2016.
32
 With the Direct Connect initiative, dealers were no longer required to maintain

their own inventories of major appliances. Instead, they could rely on GE’s virtual

inventory – a digitalized merchandizing and inventory system that allowed the

dealers to retrieve information about available appliances, sell them to their

customers, provide these customers with delivery information, and have the

appliances shipped directly to the customers from GE distribution centers. The Direct

Connect initiative not only reduced the inventory carried by dealers, but provided the

dealers’ customers with access to the full breadth of GE’s appliance product lines. GE

now links this dealer-order processing system to its forecasting and demand planning

processes, enabling GE to manufacture to the product sales rather than to dealers’

inventories.

Since 2011, GE has been transforming itself through a multibillion-dollar

initiative called the Industrial Internet. Essentially, GE has embraced the Internet of

Things and the world of Big Data by embedding sophisticated digitized sensors to its

machines and connecting the ensuing data streams to operational and analytical

platforms. While GE has long embedded sensors in its machines, the data from these

sensors was primarily accessed and used on-site by repair and maintenance

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

digitalized platforms enabling a broad spectrum of operational and managerial

processes.

As an example, consider GE’s jet engine business, whose business model is

built around the product leadership value discipline. Noticing that some of its engines

were beginning to require more frequent unscheduled maintenance, GE engineers

aggregated and analyzed real-time functioning, maintenance and performance data

33
for every jet engine in use across the globe. Through this analysis, the GE engineers

were able to identify the problem: engines operated in harsh conditions (e.g., heat,

humidity, dust, smog, etc.) tended to clog, heat up and function inefficiently. By

thoroughly cleaning the engines used on such routes more frequently, engines

operated more efficiently, required less maintenance and exhibited longer peak

lifetimes – saving airlines millions of dollars annually in fuel costs. But, designing,

building, installing, operating and maintaining state-of-the-art, interconnected

machines demands operational excellence.

All of this has dramatically transformed the business model of GE’s jet engine

business. The value proposition involves two value disciplines requiring a broad

range of core and dynamic capabilities; and, the profit model has shifted from being

based solely on revenues from sales transactions to one based on revenues from

sales transactions and from a contracted portion of airlines’ savings from better

performing engines (engine operating and maintenance costs, aircraft miles flown

per year, etc.).

Kraft Foods: Customer Intimacy in Action

In packaged food pipeline ecosystems, the focal market exchange is that

between a shopper and a retailer. For producers like Kraft Foods, the immediate

consumers, or customers, are grocery retailers. By tailoring promotions,

merchandizing and logistics relationships with retail stores (or clusters of stores

associated with the same retail chain), Kraft was among the first firms to apply

analytics in reaching out through retail stores to the stores’ consumers to benefit

both the stores and Kraft.

34
 Kraft decentralized much of its marketing to sales teams holding relationships

with retail stores (or store clusters) and built a marketing analytic capability that

combined data from three sources: digitized sales transactions from the retail stores,

demographic and buying-habit data on the customers of 30,000 food stores

nationwide, and an external geo-demographic database organized by nine-digit zip

code. A centralized group of marketing specialists and brand specialists applies

analytics to develop deep understandings of how sales of products, product

categories and brands vary by store, retailer, geographic area, customer segment,

time-of-the-year, etc., and how these sales are influenced by taken-actions, e.g.,

campaigns, coupons, sales, displays, product-shelfing, etc. This centralized group

then consults with the decentralized sales teams as the teams plan for subsequent

retail account interactions, i.e., creating customized, store-level promotional

programs.

More recently, Kraft has broadened their consumer-outreach in three major

ways. First, as Kraft now reaches shoppers through B2C sales channels (pure-play

online retailers such as Amazon and mixed-play retailers such as Target and

Walmart), Kraft’s retail analytics and retailer relationship programs have had to

account for the nuances of e-commerce. Second, while not selling directly to

shoppers, Kraft is building online shopper communities, e.g., social media channels,

www.kraftrecipes.com and the iFood Assistant app, that are used to build awareness

about and promote Kraft products and brands and to interact with shoppers. Third,

the streams of data gathered from these online communities have been incorporated

within Kraft’s analytics platforms – enabling marketing and brand specialists to tap

into the fuzzy front-ends of shopper wants and needs (e.g., flavor trends, absent-

35
but-desired products, in-store or online shopping likes/dislikes, promotions

likes/dislikes, brand perceptions, etc.). Insights such as these, when combined with

the results of more-traditional marketing analytics, can be invaluable for a broad

array of marketing decisions, including: establishing brand pricing strategies, filling

out product lines, planning joint-brand/product promotions (single product

promotions can cannibalize overall sales), and optimizing promotional spending

across media.

Apple: Product Leadership in Action

Following Steve Jobs’ leadership, Apple has very successfully pursued the

product leadership value discipline. Because Apple’s products are perceived by its

customers as innovative, trendy, reliable and easy-to-use - and as providing the

purchaser with peer-group panache - Apple is able to command premium prices for

their products. The firm has accomplished this by maintaining tight control of product

design and development and by reinforcing the Apple brand through stylistic

promotional programs and uniquely designed retail stores.

Apple’s approach to product leadership is not to tap into the leading edge of

consumer trends, but rather to inspire these trends. It is not enough to understand

your customer’s desires - Apple’s objective is to create these desires. Clear examples

of this are the iPod, the iPhone, the iPad and, most recently, the Apple Watch. The

Apple Watch, for example, is not intended to be a smaller, wearable version of the

iPhone. Instead, the Apple Watch is envisioned as a lifestyle accessory that brings

the digital content most meaningful to a person in real-time at the turn of the wrist.

Was this something that the consumer needed before it was released? Not likely.

But, it is Apple’s expectation that, after becoming aware of the usefulness of the

36
Apple Watch, its targeted consumer segments will perceive not only that this need is

real, but that it has always existed.

In order for Apple’s market success to continue into the future, two factors

are crucial: releasing a steady stream of exciting products, and growing its extremely

loyal (some might say insanely loyal) customer base. The first of these factors is

captured with the product leadership value discipline, and the second with the

customer intimacy value discipline. Apple’s more recent focus on customer intimacy

is perhaps best represented by the opening, growth and market success of the Apple

Store. As conceived by Apple, its retail stores are more than just stores. Instead,

the Apple Store is intended to be an inviting and creativity-releasing space where

people are exposed to a variety of enriching experiences: trying out new products,

learning how to do neat things with a product, overcoming product usage problems,

being exposed to new ideas (about technology, art, music, culture, entrepreneurial

startups, etc.), interacting with others on topics of mutual interest, and, most simply,

being entertained. The objective, thus, is to fashion and reinforce stronger consumer

relationships, one at a time.

Final Thoughts about Business Models

As a final point, the digital strategy for a given organization often involves

multiple business models. Multiple business models arise because most organizations

participate in multiple, differing markets. While Walmart’s digital strategy is directed

toward a single, overarching business model, Apple‘s digital strategy incorporates

two overarching business models: one associated with the consumer smart device

pipeline ecosystem, and the other with the iTunes business model that operates as a

network ecosystem. Further, while the digital strategy for a holding company such

37
as Berkshire Hathaway is framed around a single dominant business model, each

subsidiary’s digital strategy is framed around one or more self-contained business

model(s).

The Logic of Digital Strategy: Competitive Moves

The third element of the modern approach to digital strategy recognizes a

dynamic perspective realized through competitive moves and countermoves. Unlike

the traditional perspective on strategy that is based on competing around static

positions, the dynamic perspective emphasizes the continual pursuit of competitive

advantage through innovations in business models, products and services. Agile

firms regularly conduct small-scale, tightly-contained strategic experiments to

learn about potential innovations and disruptions and then adapt their business

models for strategic success. In his recent book, Venkatraman11 describes three

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

 Experimentation at the Edge

 Collision at the Core

 Reinvention at the Root

Each of these are now briefly described.

Experimentation at the Edge

Today, in virtually every industry, technology entrepreneurs are developing

new digital business models that have the potential to cause dramatic disruptions

and transformations. History is replete with examples of such disruptors: Amazon

N. Venkatraman, The Digital Matrix: New Rules for Business Transformation through
11

Technology, Life Tree Media, 2017.

38
and the retailing industry (1995), Netflix and the movie rental business (1998), Uber

and the people transportation industry (2011), Tesla and the automobile industry

(2014), etc. All firms must direct their managers’ attentions and their resources

toward understanding and recognizing the plethora of business model experiments

that might possibly affect their industry. Consider the many ongoing experiments

occurring today with Bitcoin. Though its implications and business trajectory are not

clear today, no financial services firms can afford to ignore experiments around this

fintech-created opportunity. The leadership teams of industry participants (both

incumbents and new entrants) must manage their attention toward

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

Collision at the Core

Consider the automobile industry today. Should the automotive

manufacturers still be making cars or are they in the business of mobility solutions?

The smart money would be on the latter and this would have significant implications

for the business models and ecosystems of today’s automobile industry. Apple’s Car

Play entertainment, Google’s Waymo self-driving car technologies, Peloton’s

automated transportation solutions, and Mobileye’s advanced driver assistance

systems are all examples of novel solutions that are likely to affect, in yet

undetermined ways, the core of today’s automotive industry. Every car manufacturer

is reexamining its business models, ecosystems, and offerings to develop the needed

adaptive and entrepreneurial agilities. The jury is out on how we will view cars and

mobility solutions ten years from now and what will be the ownership and

consumption models affecting the fortunes of car manufacturers. However, it is quite

clear that during the past three years, the industry’s business models are undergoing

39
significant transformations. Savvy firms participating in automobile-related

ecosystems are examining a breadth of collision at the core competitive moves

aimed at renovating industry ecosystems and business models by establishing

relationships with digital giants and technology entrepreneurs, committing to

investments in new digital capabilities, and reinventing organization structures and

incentive systems to attract the needed in-house talent.

Reinvention at the Root

It seems we continue to hear, almost daily, about the demise of the traditional

retail industry and the emergence and dramatic growth not just of Amazon, but of

other digital retail firms. The fundamental business models of retailing have been

reinvented and the industry is witnessing a shakeout, with many of the traditional

incumbents on the verge of disappearing. But, some incumbents are doing fine with

their digital transformations (e.g., Walmart, Target, Walgreens, Starbucks, Sephora,

Macy’s, Marks & Spenser, IKEA, Nordstrom, among others). Invariably, these

successful retailers: actively engage in experimentation at the edge and collision at

the core competitive moves, and introduce radical changes to their business models

as they move toward becoming, to varying extents, blended organizations.

Reinvention at the root refers to competitive moves aimed at cannibalizing

traditional capabilities and scaling up significant investments in new digitization and

digitalization capabilities.

The Logic of Digital Strategy Formulation and Evolution

Figure 2-5 depicts the central role served by competitive moves in the process

of digital strategy formulation and evolution – a process that begins and evolves

40
through the knowledge, perspectives and insights held by digital strategists. Four

domains of knowledge, perspectives and insights are especially critical:

 Currently-executing business models.

 The markets within which these business models are executing.

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

 The digitization and digitalization landscapes relevant to the currently-

executing business models and to any new business models being
formulated, especially as these landscapes affect experimentation at the
edge, collision at the core, and reinvention at the root.

Table 2-2 provides overviews of these four domains. Importantly, the key to

fabricating and evolving effective competitive moves is not necessarily the nature of

the specific planning processes applied (many differing planning processes can lead

to successful outcomes), but rather to ensure that these planning processes actively

involve participants (e.g., digital strategists, leadership team members, functional

specialists, etc.) whom collectively hold and/or have ready access to these four

domains of knowledge, perspectives and insights.

41
 Figure 2-5
The Digital Strategy Formulation and Evolution Process

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

Digital
Strategists’ Business Model
Knowledge, Enhancement,
Perspectives Replication &
& Insights Innovation

Competitive Outcomes
Targeted Market
Adjacent Markets

Table 2-2
Key Knowledge-Perspectives-Insights Domains

Target Market Adjacent Markets

• Value-units, complements,
substitutes
• Consumer expectations
• Revenue-generating tactics
• Value stream participants &
activities
Executing Business
Models
• Value proposition
• Profit model
• Core capabilities
• Dynamic capabilities
• Value-units, complements, substitutes
• Consumer expectations
• Revenue-generating tactics
• Value stream participants & activities
Digitization & Digitalization
Landscapes
• Current digitization & digitalization
capabilities
• Digital technology advances & innovations
• Digitization best-practices, trends &
innovations
• Digitalization best-practices, trends &
innovations

42
A Recap and Look Ahead

This chapter has introduced fresh ideas regarding three key elements

associated with the formulation of successful digital strategies. First, digital

strategists must focus on agility as the predominant goal in formulating their

organization’s digital strategy. Successful digital-age firms excel with both adaptive

and entrepreneurial agilities. Second, business model design represents the new

grammar through which an organization’s digital strategy is formulated and

evolved. Digital strategists’ creativity and attention must be focused on business

model design, adaptation, and reinvention in response to a plethora of digitalization

threats and opportunities. Third, the logic of digital strategy formulation and

evolution is based on taking and learning from three types of competitive moves:

experimentation at the edge, collision at the core, and reinvention at the root.

Bolstered by these ideas, we are now ready to examine how digitalization can be

applied to confront digital disruption in, first, pipeline ecosystems and, then,

network ecosystems.

43
 Chapter 3. Digitalized Business Models for Pipeline Ecosystems

Over the last century, pipeline ecosystems have been the dominant organizing

paradigm. In just about all established economic arenas, e.g., automotive, packaged

foods, personal care goods, pharmaceuticals, smartphones, mobile communication

services, healthcare services, big box retailers, etc., value-units are delivered to

consumers through tightly-coordinated value streams. This chapter examines the

nature of pipeline ecosystems by describing:

 Why Pipeline Ecosystems Exist

 Digitalizing Pipeline Ecosystems

 Disintermediation, Reintermediation and Intermediary Transformation

Why Pipeline Ecosystems Exist

Figure 3-1 depicts a simplified industry value stream for companies - like Ben

and Jerry’s, Häagen-Dazs, and Baskin Robbins - that produce ice cream (through a

mix of upstream channels) and then market finished products to consumers (through

a mix of downstream channels). In such a pipeline ecosystem, the ice cream

producer determines which ice cream raw materials, flavors and delivery channels

are likely to be most favored by consumers and fashions a value stream to produce

and deliver ice cream products to these consumers. However, if one or more of the

upstream/downstream participants does a poor job carrying out its responsibilities,

or if the ice cream producer does a poor job anticipating the consumers’ expectations

or coordinating value stream work flows, then the consumers’ expectations will not

be met. Further, because of the complexities involved in coordinating value stream

work flows, the producer could choose to perform all of the activities involved with

44
the value stream, i.e., be fully vertically integrated. However, as explained below, it

usually is neither economically nor operationally desirable for the producer to do so.

Three concepts explain why this is the case: economies of scale and scope,

transaction costs, and intermediation.

Figure 3-1
Ice Cream Industry Value Stream

Upstream Activities Midstream Activities Downstream Activities Consumers

Ice
Cream Distributors
Production

Ice Cream
Storage &
Ice Cream Shipping
Production
Ice
Cream Retailers
Ingredient
Suppliers

Retail
Store

Packaging
Suppliers

eCommerce
Paper
Suppliers

Economies of Scale and Scope

Economies of scale refers to the advantages that arise with increased volume

of output, and economies of scope refers to the advantages that arise when a

family of related goods are produced rather than a single good. Viewed most

simplistically: by covering fixed costs with larger activity volume, the cost to execute

the activity drops; by specializing in an activity, the activity’s variable costs can be

reduced through experience, analysis and training; by performing a set of similar

activities, the fixed and variable costs of each activity can be reduced. It is the
45
existence of economies of scale and scope that are at the basis of the consideration

given by most producers to using the services of other organizations to carry out

many, if not most, value stream work activities.

Transaction Costs

Transaction costs are involved with a fundamental market-related decision,

generally referred to as the make-versus-buy decision: when does a company

(individual) decide to make an item or perform an activity itself (herself) rather than

another company (person) make the item or perform the activity? Answering this

question is intuitively simple: compare the total cost of doing it yourself against the

total cost of having someone else doing it for you.

The total cost to produce an item or perform an activity can be represented as

sum of associated production and transaction costs. Production costs are the direct

costs to produce an item or perform an activity; transaction costs are the additional

costs involved when an item or activity is acquired from someone else. Table 3-1

defines common transaction costs.

46
 Table 3-1
Common Transaction Costs

Types of
Transaction Description
Costs
Locating suppliers willing & able to provide goods & services.
Search
Locating buyers willing & able to purchase good & services.
Assessing bids.
Bid Selection Assessing suppliers/buyers.
Selecting a supplier/buyer.
Contract Determining mutually agreeable contract provisions.
Negotiation Renegotiating contract provisions.
Insuring against failure to deliver/purchase.
Bonding
Insuring against substandard performance.
Legal Insuring against inadequate contract provisions.
Monitoring ongoing supplier/customer performance.
Monitoring
Deciding to terminate or renegotiate contract.

Because of economies of scale and scope, organizations specializing in

producing a family of items or performing a family of activities have the potential to

provide higher-quality, lower-cost goods and services than does a non-specialist.

However, acquiring an item or a service from a specialist always involves transaction

costs (refer back to Table 3-1). The key question, thus, becomes: “Overall, is it less

expensive to do it myself or to have the specialist do it for me?” Often, the answer

is to have the specialist do it for you.

Intermediation

Intermediation refers to an organization’s choosing to reach suppliers or end

consumers through another organization, an intermediary, rather than directly.

Say, for example, that you would like a dish of ice cream made by a specific ice cream

producer. You could buy a pint directly from a retail store operated by the producer

or from a nearby grocery store (who buys the ice cream directly from the producer

or, more likely, from a distributor or wholesaler). Unless you live close to a producer
47
retail outlet, the transaction costs (e.g., search, travel, etc.) you would experience

are likely to be quite high. As a result, you would not buy a pint of ice cream directly

from the ice cream producer; instead, you would buy a pint from a nearby grocery

store. Because of such difficulties faced by producers in reaching consumers, most

producers use downstream intermediaries in order to reach a large number of

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

intermediaries. Table 3-2 describes common activities undertaken by intermediaries.

Table 3-2
Common Intermediary Activities

Types of Activities
Performed by Description
Intermediaries
Locate & procure products/services/information.
Search Efficiency
Locate suppliers.
Gather orders from multiple consumers and negotiate
prices & contracts with producers.
Demand Aggregation
Gather products/services/information from multiple
suppliers and negotiate prices & contracts with producers.
Buy in bulk and reassemble into packages that meet the
Create Packages
needs of specific consumers or producers.
Handle complex transactions.
Guarantee Transactions
Insure payments & shipments.

Manage Logistics Delivery of goods: upstream & downstream.

Adding a new intermediary to an existing value stream always introduces

additional costs, as each intermediary naturally wishes to make a profit from their

involvement in the value stream. However, as these additional profits are spread

across the large number of value-units moving through the value stream, it often

proves to be the case that both producers and consumers ultimately benefit from the

presence of the new intermediary.

48
Digitalizing Pipeline Ecosystems

The nature of market-focused ecosystems has evolved dramatically over the

three eras of digital disruption, particularly with regard to the value-units delivered

to consumers, the enabling digitization and digitalization, and the payment and trust

systems employed. Table 3-3 provides an overview of the major changes that have

occurred. The most significant of these changes for pipeline ecosystems are

described below. Each one of the three eras of digital disruption within pipeline

ecosystems is now described, with this section ending with a discussion of how these

changes have resulted in the value streams associated with pipeline ecosystems

being disintermediated, reintermediated and characterized by intermediary

transformation.

Table 3-3
Evolution of Pipeline Ecosystems

Exchange Trust
Era Value-Units Digitization & Digitalization
Currency Systems
 Data/document standards  Government & third-
 Banking
 Point-to-point connectivity party institutions
Digital system
1  Intra- and inter-organizational  Contracts
complements  Credit/debit
(managerial & operational)  Brand
card systems
business process efficiencies  Social capital

 Internet
 One-to-many connectivity  Third-party digital
 Data, process, analytic &  Digitalized trust seals
Digital
2 collaboration platforms payment  Consumer
value-units
 Social media systems monitoring (product
 Omni-channel producer- & producer reviews)
consumer interaction

 Many-to-many connectivity
 Community
 Smart devices  Reputation
Social monitoring
3  Big data platforms  Social capital
complements  Peer-regulation
 Big data analytic platforms  Bitcoins
 Self-regulation
 Social messaging platforms

49
Era 1

Leadership teams of organization-participants within pipeline ecosystems

expect their operations, staff and managerial employees to be looking for ways to

enhance value-units, cut costs, improve market responsiveness, and accelerate the

development of new, revenue-generating value-units. These beneficial outcomes all

derive from efforts taken to improve organizations’ internal managerial and

operational processes. Figure 3-2 provides a way to conceptualize these processes.12

Primary processes refer to work activities directly involved in delivering value-units

to customers, and support processes refer to work activities that provide direction,

resources and oversight for the primary processes. All too often, however, these

work activities are hindered by constraints – both real (e.g., time, space, resource

limitations, etc.) and imagined (i.e., ingrained in employees’ thinking as a result of

culture, history, inadequate supervisory direction, inadequate training, etc.).

This conceptualization is derived from ideas introduced by: M. E. Porter, Competitive

12

Advantage: Creating and Sustaining Superior Performance, New York: Free Press, 1998.
50
 Figure 3-2
A Pipeline Organization’s Managerial and Operational Processes

Business/Digital Strategizing; Administrative Services

Financial Services; Accounting Services

Digital Technology Services & Management

Processes
Support

Human Resource Recruitment & Development; Benefits Management

R&D; New Product Development; New Product Rollout

Indirect Materials & Supplies Procurement

Order
Manufacturing
Direct Fulfillment
Processes

Materials Work-in- Customer

Primary

Finished- Sales
and Supplies Process Support
Goods
Procurement Inventory Marketing
Inventory Reverse
Inbound Quality Merchandising Logistics
Outbound
Logistics Control
Logistics

The availability of new digital technologies, industry data/document standards

and results from analyzing digitized transactional data proved instrumental in

enabling value stream participants to overcome many of the constraints that

otherwise were inhibiting efforts to improve internal processes and external

workflows. Data/document standards allow data and documents to be accessed

and used by value stream participants. For example, many industry groups

developed data and document specifications as a means of facilitating B2B

transaction flows. This was referred to as EDI (Electronic Data Interchange). As

might be expected, EDI made it possible for value stream participants to interconnect

their (increasingly-digitized) workflows. When operational processes improve within

and across a value stream’s participants, two things occur. First, the performance of

the entire value stream improves – to the benefit of all participants, but especially

51
for consumers. Second, as intermediaries are specialized to a greater extent than

are producers, intermediaries are able to more-quickly apply process improvements

to enhance their business models. As a result, intermediaries tended to gain

increased influence in value streams and, correspondingly, to increase their relative

shares of the value being created. However, such gains in the influence of

intermediaries were somewhat attenuated by the abilities of creative producers to

lower their cost structures and to attach digital complements (e.g., better and more

information, information-based services, product/service migration paths, etc.) to

the value-units being delivered to, thereby enhancing the producer’s value-

proposition and strengthening both the producer’s market position and relative

influence within the value stream.

For the most part, Era 1 pipeline ecosystems made use of well-established

payment and trust systems. The only true innovation that occurred was the

emergence of a digitally-enabled payment system: credit and debit card payment

systems.

Era 2

The digital technology that ushered in Era 2 was the development and wide-

spread adoption of the World Wide Web. At its core, the WWW (World Wide Web)

serves as a one-to-many connectivity mechanism enabling organizations (and

individuals) to store data and documents in an online space such that these data and

documents can easily and inexpensively be accessed and used by other organizations

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

digitalization innovations that irreversibly disrupted pipeline ecosystems: purely-

digital value-units, platforms, and omni-channel promotion, ordering and delivery.

52
 Purely-Digital Value-Units

Like their physical counterparts, purely-digital value-units do not exist in a

vacuum but require a vast enabling-ecosystem. For example, consider a very familiar

physical product – the automobile. In order for you to buy a car directly off of the

sales lot and drive it, a huge number and variety of things must exist: automobile

retailers, service/repair shops, insurance providers, fuel stations, roadways, traffic

lights and signage, traffic laws and regulations, etc. Most important, a

correspondingly huge number of standards need to have been established and need

to be followed in order for the entire automobile ecosystem to operate seamlessly.

A similar enabling-ecosystem needs to exist for purely-digital value-units, such

as digital books, mp3 audio tracks, navigation maps, and digital coupons. Devices

must exist through which a purchased value-unit can be accessed and used, retailers

must exist to offer the value-unit to a consumer and then deliver a purchased copy

to the consumer’s device, and payment systems must exist so that the exchange can

take place between the retailer and the consumer. As with physical goods, many

standards must be established and followed for the ecosystem to operate seamlessly.

Although physical and digital value-units both require enabling-ecosystems,

the markets for physical and digital value-units differ in two major ways. First, the

cost-structures of digital value-units tend to be much lower than the cost-structures

of physical value-units. Second, long-tail effects characterize digital value-unit

markets to a much greater extent than physical value-unit markets.

Relative to digital value-units, physical value units have moderate-to-high

initial costs (e.g., design, testing and marketing) and moderate-to-high variable

production costs (e.g., labor and materials). Let us compare the costs between

53
manufacturing a car and developing a digital book. Car manufacturers incur high

fixed costs (e.g., large plants, sophisticated manufacturing and design technologies,

etc.) and high variable costs (e.g., parts and assembled components, labor). In

contrast, while a digital book may have high initial costs (the labor costs involved in

authoring, editing and formatting the book), a digital book has very low variable

production costs - often approaching zero. This is because the costs of replicating

digital goods are minimal, unlike most physical goods. For example, the 100th car

coming off of an assembly line will cost essentially the same to produce as the first

car off of said assembly line. However, the 100th digital copy of a text book costs

only a minute fraction of the expense involved in producing the first digital version.

The production costs associated with digital goods are dominated by the cost of

producing a first copy, with few constraints limiting growth in demand. Simply put,

digital goods have far more opportunities for large-scale growth than do physical

goods.

The long-tail phenomenon refers to the ability of digital markets to offer a

far broader variety of value-units than could be offered in comparable physical

markets. Participants in physical markets are constrained in the breadth of value-

units being offered because of the costs of holding inventory. Generally, firms strive

to offer the 20% of value-units that generate 80% of sales. It simply is not

economical to cater to the remaining 80%. Consider a hardcopy book that was a

bestseller a year ago, but has since been displaced by more recent bestsellers. Even

though a small demand for this hardcopy book is likely to persist over time, most

hardcopy retailers will keep few, if any, copies of the book on hand due to acquisition

costs and physical storage space constraints. Similarly, consider a book on hiking in

54
the Andes mountain ranges written by an authoritative expert. While there might be

a sizeable demand for such a book among hiking enthusiasts (especially those

planning a near-term hiking expedition in the Andes), the book is unlikely to have

the broad popularity needed to merit space on most hardcopy retailer’s bookshelves

(unless, perhaps, you walk into a bookstore in Cuzco, Peru).

On the other hand, digital retailers are finding it profitable to service the needs

of customers whose tastes represent the more specialized products populating the

long-tail of the demand spectrum. For example, an MIT study from the early 2000s

found that nearly 30-40% of Amazon’s book sales represent products in this long-

tail.13 This ability of digital markets to service the long-tail of demand can be

explained by a number of factors:

 Digital retailers experience lower costs of stocking inventory because they

do not use physical shelf space to stock and display their products. Instead,
they apply digitalized product inventories, often including products held by
other ecosystem participants.

 Digital retailers experience lower costs of promotion and advertising via a

proliferation of Internet and social media sites.

 Digital retailers experience lower acquisition costs.

 Digital markets are not constrained by geography. They can reach

customers locally, regionally, nationally or globally. At that scale, digitized
retailers can aggregate the demand for niche products to achieve dramatic
scale economies.

 Digital consumers can make use of digitalized search mechanisms to locate

digital retailers and specific digital value-units.

 Digital consumers have access to massive amounts of value-unit-related

information (e.g., reviews of specific value-units or of value-unit categories,
such as lists of the best point-and-shoot cameras).

E. Brynjolfsson, Y. Hu, and M. D. Smith, "From Niches to Riches: Anatomy of the

13

Long Tail," Sloan Management Review, Summer 2006, pp. 67-71.

55
 Platforms

Value streams in pipeline ecosystems become longer and wider each time

another upstream or downstream intermediary is added. Although each added-

participant offers new capabilities to be leveraged, the complexities involved in

coordinating data, information and material flows between value stream participants

increase as well.

Consider the value stream shown in Figure 3-3. Note that numerous

data/information flows and material flows are involved, and that all of these flows

occur between adjoining participants. Each participant determines demand forecasts

from data and information provided by only the most adjacent participants. Without

access to consolidated data from all participants in a value stream, these forecasts

tend to be error-prone, erratic and worsen over time. Participants experiencing high

levels of demand uncertainty often suffer late deliveries, overstocking, high

expediting costs, stressed employees, dissatisfied customers, and lost revenue.

Figure 3-3
Conventional Value Stream

Tiered
Suppliers
Contract
Manufacturers

Assemblers Data & Information Flows

Producer
Material Flows
Distributors

Retailers

Consumers

56
 Value stream participants developed tactics to deal with demand uncertainty,

the two most common being vertical integration and stock holding. With vertical

integration, an organization chooses to do more value stream activities itself, thus

shortening and narrowing its value stream. But, in doing so, the advantages gained

through specialization and intermediation are lost. With stock holding, an

organization builds up various kinds of inventories, thus providing buffers that soften

the effects of poor demand forecasts. But, in doing so, higher inventory costs arise

that can lead to higher prices (stressing consumer demand) and/or lower profit

margins.

Era 2 digitalization provided a much better way to cope with the challenges of

long and wide industry value streams. Figure 3-4 depicts a platform-enabled value

stream. In general terms, a platform uses digital technologies to host digital and

digitally-enabled resources. In this case of a value stream platform, these hosted

resources are likely to include: digitized data and documents, digitalized managerial

and operational processes that operate on these data/documents, tools for analyzing

data, and tools enabling employees from participating organizations to interact and

collaborate. By using the resources available through value stream platforms, value

stream participants can: better plan their own work activities; better plan and then

coordinate the data, information and material flows that permeate a value stream;

and, collaborate to resolve problems that arise.

57
 Figure 3-4
Platform-Enabled Value Stream

Tiered
Suppliers

Contract
Manufacturers

Assemblers Value Stream Platform

 Data/Documents
 Processes
Producer  Analytic Tools
 Collaboration Tools
Distributors

Data & Information Flows

Retailers

Material Flows

Consumers

Many successful value stream platforms have been built, owned and

managed by powerful value stream participants. Classic examples include Dell’s

platform for executing its build-to-order business model (see Figure 3-5) and

Enterprise Rent-A-Car’s platform for executing its repair rental car business model

(see Figure 3-6). Considerable efforts have been taken by industry consortiums,

(e.g., electronics manufacturing, automobile manufacturing, chemical production,

etc.), to define and implement platforms to be used across the varied value streams

that comprise these industries’ market ecosystems.

58
 Figure 3-5
Dell’s Value Stream Platform

Data & Information Flows

Product & Material Flows

Contracted Outbound
Component (Downstream)
Assembler
Suppliers & Logistics
Contract Provider
Manufacturers

Dell’s Value
Inbound Stream Platform
(Upstream)
Logistics
Providers
Dell Consumer

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

Data & Information Flows

Insurance
Companies

Enterprise’s
Enterprise
Value Stream Consumer
Rent-A-Car
Platform

Auto
Repair
Shops

Omni-Channel Promotion, Ordering and Delivery

As Era 2 progressed, advances with WWW technologies accelerated, increasing

the functionality, ease-of-use and availability of value stream platforms. One of the

key targets of platform enhancement involves the variety of channels used for
59
promotion, ordering and delivery activities (see Table 3-4). As a consequence, value

stream participants enlarged the portfolio of channels through which participant

interactions occurred. Such interactions involve data, information and/or material

flows between:

 Participants’ digitalized processes (e.g., a producer’s component ordering

system interacts with a supplier’s sales order processing system).

 Participants’ employees (e.g., a producer’s purchasing clerk interacts with a

supplier’s customer support representative via a series of texts).

 A participant’s digitalized process and another participant’s employee (e.g.,

a producer’s purchasing clerk interacts with a supplier’s order tracking
system).

 A participant’s digitalized process and an individual consumer (e.g., a

consumer interacts with a producer’s online storefront).

 A participant’s employee and an individual consumer (e.g., a consumer

interacts with a producer’s customer support representative via an online
chat capability).

 Two (or more) individual consumers (e.g., two consumers interact through a
producer’s online customer forum).

Table 3-4
Value Stream Participant Interaction Channels

Era 1 Channels Era 2 Channels

Medium Ordering & Ordering &
Promotion Promotion
Delivery Delivery
Radio Retail Store Internet Ads eCommerce
Television Producer Website B2C
Print Retailer Website B2B
Mass Magazines Informational Websites
Newspapers Posted Reviews
Catalogs Messaging
Direct Mail email/text
Telephone Mail Services Search-Targeted Ads Messaging
Face-to-Face Parcel Services Messaging
Personal Telephone email/text/chat
Face-to-Face
Group Event Group Event Social Media Groups
Avon Messaging
Social Tupperware Interactions
Targeted Ads
Blogs

60
 Payment and Trust Systems

The accelerating growth of B2C e-commerce witnessed innovations in both

payment systems and trust systems. Purely-digital alternatives, such as PayPal and

Amazon’s 1-Click, have emerged in response to consumers’ desire for more

accessible and convenient payment systems for online transactions. Similarly,

innovations were targeted at increasing consumers’ willingness to engage with e-

commerce retailers (e.g., third-party institutions such as VeriSign) and to purchase

products on a sight-unseen basis (e.g., consumer reviews). Consumer reviews, in

particular, have become a culturally-accepted trust mechanism, despite concerns14

about fake reviews and a tendency for contributed reviews to possess a socially-

influenced bias toward positive ratings.

Era 3

Era 3 digitalization emerged largely as a consequence of the coming together

of smart devices, value-unit social media complements and pervasive connectivity.

A smart device refers to an assembled piece of digital technology (e.g., a product,

a component, a tool, an accessory, etc.) that provides a digital capability to sense,

analyze and act on environmental signals. Table 3-5 describes some familiar but, in

contrast to what is happening today, not-so-smart smart devices. Value-unit social

media complements refer to the opportunities made available to value-unit

consumers to engage with the value-unit’s producer and/or retailer and with other

consumers via social media. Pervasive connectivity is a characteristic of an

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

pp. 47-52.
61
ecosystem where collections of smart devices across the ecosystem are

interconnected, thus creating opportunities for anywhere, anytime interaction; these

interactions contribute (e.g., sensed data, novel ideas, reviews, etc.) significantly to

business model value propositions. How are individuals (typically, employees and/or

consumers) motivated to contribute to the ecosystem? While (direct or indirect)

monetary payment has traditionally been a dominant primary mechanism, alternative

mechanisms - reputation and social capital - are proving to be equally, if not more,

effective.

Table 3-5
Some Familiar Smart Devices

Device What is Sensed What Action is Taken

Smartphone Screen icon touch An app is launched
Home Furnace (air conditioner) turned on when
Ambient room temperature
Thermostat ambient temperature too low (high)
Tire Pressure Dashboard icon lights up when the tire’s air
A tire’s current air pressure
Sensor pressure is too low

Smart The condition of a A display icon lights up when the water

Refrigerator refrigerator’s water filter filter needs to be changed

Vehicle Satellite signals indicating An icon is positioned on a displayed digital

Navigation GPS the coordinates of the map that indicates the vehicle’s position,
Unit unit’s geographic location direction & speed
The force exerted on a
Shipment Unit If sufficient force is detected, the shipped
shipped unit if and when
Packaging unit is returned to the point of origination
the unit shifts or drops
Sensor for damage assessment
while in transit
Electronic
A series of pre-programmed tests are
Device Fault- Temperature of the device
performed on the device’s circuitry
Diagnosis

The pervasive connectivity of smart devices can produce huge volumes of

streamed data, popularly referred to as Big Data, to be captured, organized and

analyzed. Era 3 digitalization enables value stream participants to: maintain an

awareness of targeted events occurring across a value stream, as well as within

adjacent value streams; to capture data about these events; and, to apply statistical

62
and mathematical models to these data in developing deeper understandings of the

competitive context, of value stream participants (e.g., raw material suppliers,

component suppliers, services providers, downstream-consumers, etc.), and of

specific competitive situations. Table 3-6 provides two relatively straightforward

examples of the benefits obtainable from Big Data analytics.

Table 3-6
Big Data Analytics Examples

Bicycle Pump Producer City of Boston

Buzz Analytics Street Bump iPhone App
Digitalization
Captured consumers’ messages on social media Drivers turn on app and placed iPhone on car
(Facebook, Twitter, etc.) about bicycle pumps. dashboard.

Analyzed messages to prioritize pump features and to
identify the weaknesses of the producer’s pump vis-a-vis
competitors’ pumps: less durable, hose harder to use,
and contained a costly but low-ranked built-in gauge.
Tearing down competitors’ products revealed higher-
quality components and less bulky packaging.
Outcomes
Removed pressure gauge and reduced packaging.
Applied cost savings to use higher-quality components.
Source
D. Fedewa, G. L. Velarde and B. O’Neill, “Using Buzz
Analytics to Gain a Product and Marketing Edge,”
McKinsey Quarterly, Number 2, 2016, pp. 14-15.
App captures data about potholes encountered
(location, estimated depth/size, etc.) and transmits
these data to a City of Boston data server.
Captured data cleansed (e.g., non-pothole bumps
filtered out) & analyzed to prepare listings of
potential potholes to be filled.
Potholes fixed before they become major road
hazards and while repair costs are relatively low.
Recurrent potholes can signal serious road
management problems.
D. O’Leary, “Exploiting Big Data from Mobile Device
Sensor-Based Apps: Challenges and Benefits,” MIS
Quarterly Executive, December 2013, pp. 179-187.

This capability to capture, archive and analyze large streams of transaction-

related data has made viable a new trust mechanism: self-regulation. With self-

regulation, an organization captures data associated with critical market-related

transactions, monitors these data for problems, reacts responsively and responsibly

if (and when) problems arise, and keeps (governmental or third-party) regulators

and value stream participants aware of these activities.

63
The Promise of Car Data15

To catch a glimpse of what is on the horizon as Era 3 progresses and intensifies,

let us take a not-so-futuristic look at how Big Data analytics is changing automotive-

related competitive contexts.

During the coming decade, technology entrepreneurs and digital giants are

expected to partner with incumbents in the automotive industry to exploit an

expected surge in the availability of car data and to introduce innovative car-related

features and services for which consumers are expected to be very willing to pay.

What exactly is car data? A short list would include data about: the road and

environmental conditions, the status of a car’s various components (e.g., engine,

battery, tires, etc.) and systems (e.g., power, steering, safety, etc.), vehicle usage

history (e.g., speed, direction, location, past and current trips, etc.),

driver/passenger personal data and preferences, and direct communications from the

vehicle (e.g., phone, text, email, calendar, social media, etc.). At present, a key

unknown is: “Will most people be willing to share this information for free?” Most

observers feel the answer will be Yes given the immediate benefits to be derived by

a vehicle’s driver and passengers (see Table 3-7). What do you think?

15
This section is based on material from: D. Mohr, G. Camplone, D. Wee, T. Moller
and M. Bertoncello, “Car data: Paving the Way to Value-Creating Mobility”, McKinsey
Quarterly, March 2016: https://www.mckinsey.de/files/mckinsey_car_data_march_2016.pdf
64
 Table 3-7
Immediate Driver/Passenger Benefits from Sharing Car Data

Safety
 Real-time emergency calls
 Early on-scene accident reporting
 Information to support rescue
services
 Real-time road hazard warning
Convenience
 Reduced breakdown risk and vehicle
downtime through predictive
maintenance and connections with
repair & spare parts service
providers
 Concierge services (refueling,
carwash, in-trunk delivery)
 Overall, a more-connected lifestyle
Time
 Reduced travel time through
optimized routing, navigation &
traffic management systems
 Reduced time to locate parking
through connections with parking
services
Cost
 Reduced insurance cost through
pay-as-you-drive insurance
schemes
 Reduced toll/road tax rates
through an automated payment
infrastructure

Why is this scenario so appealing to ecosystem participants? The answer lies

in both sides of the profit model component of a business model: generating revenue

and reducing cost. New sources of revenues include: selling or leasing new products

and services to car owners, leveraging car data with other sources of data to push

tailored advertisements to drivers and passengers, and selling/leasing curated car

data to third-parties. New means of cutting costs involve creative uses of car data

and car connectivity to reduce the R&D, production, delivery and marketing costs

associated with automobile-related products and services. In essence, the

connected-car is increasingly being seen as the first step into the store and, when

combined with autonomous driving, as a prime space for retail where producers and

retailers directly interact with a captive consumer.

Disintermediation, Reintermediation and Intermediary Transformation

Over the last two decades, digital disruption has introduced seemingly constant

participant turnover into most pipeline ecosystems. Established organizations are

frequently losing prominence in markets and, not infrequently, exiting markets –

65
think Borders, Blockbuster and Circuit City. Simultaneously, scores of new, highly-

digitalized entrants are participating in these same markets (as well as discovering

new, profitable niches in existing markets or creating entirely new markets).

Today, the ever-accumulating stocks of digitalization capabilities arising from

the three eras of digital disruption have seeded and continue to see radical structural

changes in pipeline ecosystems. The primary drivers of these ecosystem structural

changes are disintermediation, reintermediation and intermediary transformation.

Disintermediation occurs when an intermediary is bypassed, thus shortening and

narrowing a value stream. Reintermediation occurs with the appearance of a new

intermediary, whose presence lengthens and broadens a value stream.

Intermediary transformation occurs when an existing intermediary vertically

integrates, thus becoming a producer. Table 3-8 describes these structural change-

events for the upstream and downstream segments of pipeline ecosystems. Below,

we provide examples of each type of change-event for the downstream context.

66
 Table 3-8
Value Stream Structural Change-Events

Downstream
Producer bypasses intermediaries to directly engage in market exchanges with
Disintermediation
consumers.
Entry of digitalized retailer, whom facilitates market exchanges between producers &
consumers.
Reintermediation
Entry of digitalized infomediary (an intermediary dealing solely with data & information),
whom identifies sought value-units and/or producers to consumers.
Intermediary Intermediary integrates backwards to become a producer creating & delivering value-
Transformation units to consumers.
Upstream
Producer bypasses intermediaries to directly engage in market exchanges with raw
material suppliers, component suppliers and/or service providers.
Disintermediation
Supplier bypasses intermediaries to directly engage in market exchanges with producers
and/or bypasses producers to directly engage in market exchanges with consumers.
Entry of digitalized distributor facilitating market exchanges between producers & raw
material suppliers, component suppliers and/or service providers.
Reintermediation
Entry of digitalized infomediary identifying sought raw materials, components & services,
as well as suppliers/providers, to producers.
Intermediary Intermediary integrates backwards to become a producer, creating and delivering value-
Transformation units to suppliers, intermediaries, producers and/or consumers.

Almost all producers in consumer markets (e.g., clothing, shoes, digital

devices, furniture, grocery products, art, music, etc.) are disintermediating, to

varying extents, their downstream ecosystem via a B2C sales channel. B2C channels

provide many benefits – most are obvious, but some are not-so-obvious - to

producers and to consumers. Producers enjoy: a new revenue-generating sales

channel complementing, rather than cannibalizing, existing sales channels; higher

profit-margins on B2C sales, especially with overstocked items; the opportunity to

directly touch and interact with consumers, building loyalty and engagement; and,

the opportunity to indirectly and directly involve consumers in new product

development activities. Consumers enjoy: access to a producer’s entire product line

and to product-support content; immediate, and often early, access to a producer’s

new and overstocked products; the ability to express feelings of satisfaction and

67
dissatisfaction directly to a producer; opportunities to engage with the producer and

with other consumers in learning about a product and product-related activities; and,

opportunities to influence a producer’s next generation of products. Who loses?

Clearly, the intermediaries, i.e., distributors and retailers, who have been partially or

fully disintermediated.

As described in Table 3-8, there are two primary reintermediation pathways

with downstream ecosystems: the entry of a digitalized intermediary and the entry

of a digitalized infomediary. An infomediary is a digitized intermediary that gathers

content from across the WWW, curates the content and provides access to this

curated content. Amazon’s foray into the retail marketplace for books is the iconic

example of a digitalized entrant serving as disruptive intermediary, and Google’s

reshaping of Internet search is the iconic example of a digitalized entrant serving as

a disruptive infomediary.

Finally, highly-capable and influential intermediaries able to develop deep

knowledge of a pipeline ecosystem may be able to exploit this knowledge to become

a producer of the value-units being delivered to consumers. Two examples nicely

illustrate the breadth of possibilities. Netflix successfully disrupted the pipeline

ecosystem for film and television video not once, but twice: first as a partially-

digitalized intermediary renting DVDs, and later as a fully-digitalized intermediary

streaming video provider. Now, Netflix is producing and delivering its own content,

strengthening its ecosystem influence such that the company is universally

recognized both as one of the industry’s more powerful and innovative players.

Amazon, on the other hand, has followed two very different paths in becoming a

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

68
ecosystem that creates and delivers books to consumers and (2) strong digital

capabilities as this ecosystem transitioned from hardcopy to digital books, Amazon

has become a successful publisher of digital books through its Kindle Direct Publishing

operation. Again, having by necessity developed superb digitalization capabilities in

executing its massive B2C and B2B business models, Amazon has also become a

successful provider of digitization services (e.g., computer processing power, data

storage, content management, etc.) through its Amazon Web Services operation.

A Recap and Look Ahead

This chapter has both explained the economic foundations that have enabled

pipeline ecosystems to dominate most industries over the past century and the

manner by which digitization and digitalization have transformed pipeline

organizations and pipeline ecosystems over the three eras of digital disruption. Given

this understanding of pipeline ecosystems, the next chapter examines digital strategy

formulation and evolution for pipeline organizations.

69
 Chapter 4. Digital Strategy Formulation for Pipeline Organizations

Today, most of the data and documents that move between and within value

stream participants in a pipeline ecosystem, as well as most of these participants’

operational and managerial processes, are extensively digitalized. As a result,

digitized data and documents can be quickly accessed, absorbed and shared,

reassembled for new uses, and analyzed to produce specific answers, fresh insights

and reports. Digitalized processes can be quickly executed, incrementally or radically

modified, adapted to new contexts, and analyzed to recover the knowledge

embedded within a process’s logic. Importantly, the greater the extent of

data/document digitization and of process digitalization, the easier it becomes for an

organization’s leadership team to display adaptive and entrepreneurial agilities.

This chapter builds upon the earlier ideas provided on digital strategy

fundamentals and on pipeline ecosystems by providing insights about the digital

strategy formulation for pipeline organizations. It covers the following topics:

 Digitalization and the Value Disciplines

 Platform Design

 Platforms and the Domains of Digitalization

 Digital Strategy Formulation

 Digital Strategy Formulation in Practice

 Sustaining Held Competitive Positions

Digitalization and the Value Disciplines

Value disciplines are incorporated within an organization’s digital strategies

through a collective mindset and capabilities for execution. Today, many of the

70
needed capabilities are provided through the technical services being hosted on

digital platforms and through the operational and managerial business processes

being hosted on business platforms. Invariably, a business platform makes use of

multiple digital platforms.

Table 4-1 sums up how the engines of digitalization (automation, control,

empowerment and interaction) can enhance business processes associated with each

of the three value disciplines. Two significant trends regarding digital strategies are

reflected in just such investments in digitalized business platforms.

Table 4-1
Enhancing the Value Disciplines via Digitalization

Digitalization Value Discipline

Engine Operational Excellence Customer Intimacy Product Leadership
Upstream, midstream & R&D, product commercialization,
Availability of a broad range
downstream work activities quality assurance & after-sales
of media channels through
Automation handled quickly, accurately support work activities handled
which customers are
& completely in a less- quickly, accurately & completely in
touched.
costly, more-timely manner. a less-costly, more-timely manner.
Digitalized business solutions &
Fewer suboptimal actions Digitalized business
employees engaged in R&D, product
taken and quicker sensing of solutions & employees
Control commercialization, quality
exceptional or changed touching customers produce
assurance & after-sales support
situational contexts. fewer suboptimal results.
produce fewer suboptimal results.
Employees engaged in
Employees touching Employees engaged in R&D, product
operational/managerial
customers are better commercialization, quality
Empowerment work produce fewer poorly-
informed about the assurance & after-sales support are
informed or ill-informed
customer and the situation. better informed.
results.
Employees engaged in R&D, product
Digitalized business
Customers & customer commercialization, quality
solutions & employees
communities can be assurance & after-sales support can
Interaction engaged in work activities
engaged across time and engage one another, employees of
exchange more & better
space. strategic partners & customer
data & information.
communities.

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

entrepreneurial agilities. As more competitors in a market-focused ecosystem

demonstrate these agilities, the pace at which organizations must implement and

respond to competitive actions quickens dramatically. Since the competitive actions

71
taken by competitors emphasize differing value disciplines, organizations striving to

gain a competitive advantage or maintain competitive parity are increasingly forced

to target multiple value disciplines. Vivid examples of this phenomenon were

provided in Chapter 2’s discussions of General Electric and Apple.

Second, many of the core capabilities needed for organizations to achieve

competitive parity are increasingly available from technology providers in the form

of pre-packaged business platforms. Digitally-savvy organizations can quickly

acquire a business platform, integrate the acquired platform within its installed

assemblage of digital platforms and business platforms, and competitively exploit this

expanded set of capabilities. Essentially, such practices find organizations innovating

by imitating other firms’ innovations – a much-faster and less-risky form of

innovation.16 However, such practices only serve to further speed up the pace of

competition within market-focused ecosystems.

Platform Design

Well-architected platforms are the means by which organizations are able to

evolve their business models and execute competitive actions in a timely manner.

But, what exactly is meant by a well-architected platform? A well-architected

platform exhibits an appropriate balance in (1) the stability and agility of the hosted

functionality and (2) the costs of building, enhancing and extending platforms across

functional, unit and organization boundaries. In order to fabricate a well-architected

platform, three design issues must be addressed: modularity; tight-coupling vs.

loose-coupling; and, global vs. local.

16
O. Shenkar, Copycats: How Smart Companies Use Imitation to Gain a Strategic
Edge, Boston: Harvard Business School Publishing, 2010.
72
Modularity

With modularity, each of a platform’s major functionalities, or modules,

operates independent of other functionalities and obtains needed information or

resources from a common coordinating module. Therefore, it is easy to add modules

to or remove modules from the platform. Additionally, once a platform is built, it is

relatively easy to modify any of the platform’s modules.

Tight-Coupling and Loose-Coupling

Tight-coupling and loose-coupling refer to the nature of the interconnections

that enable data, messages and documents to be exchanged between platforms.

With tight-coupling, one or both of the interconnected platforms are modified so

that the data, messages and/or documents being exchanged are consistently

interpreted across both platforms. Because the required modifications require both

time and effort, tight-coupling can be very intrusive for one or both of the platforms.

With loose-coupling, one of two tactics is generally applied:

 Some form of interconnection component is used to translate the data,

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

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

Both of the loose-coupling tactics are far less intrusive than tight-coupling.

Figures 4-1 and 4-2 contrast tight-coupling and loose-coupling. In general,

tight-coupling can provide for greater stability (being seamless and using less

73
complex technology, it is easier to harden and secure) and loose-coupling can provide

for greater agility (both the platform and its connections to other platforms are easier

to modify). In terms of cost, initial connection costs are greater with loose-coupling,

but subsequent connection costs tend to be less.

Figure 4-1
Tight-Coupling and Loose-Coupling

data, messages, documents

Tightly Module A Module B

Coupled

data, messages, documents

• Interconnection Artifact
Loosely Module A Module B
Coupled • Agreed-to Standards

74
 Figure 4-2
Contrasting Tight-Coupling and Loose-Coupling

• Seamless
• Less Complex Technologies

Tightly-Coupled
Loosely-Coupled

• More Intrusive
• Best for a One-to-One connection

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

Global and Local

The term global, as used throughout this book, refers to a digital solution that

is designed and built to be used by most of an organization’s work units (another

term often used to connote a global digital solution is enterprise-wide). A local digital

solution is designed and built to be used by one or only a few of an organization’s

work units.

Figure 4-3 summarizes the advantages of global and local platforms. Global

platforms are more cost-effective to build, support and modify because associated

costs are spread across a large base of users. Additionally, the digital solutions that

comprise global platforms are highly-leverageable, as these solutions can be reused

as new functionalities are appended to a platform. However, considerable time and

effort is required to negotiate the design of and to implement global platforms (as

well as subsequent modifications to global platforms). Further, it is all too often

75
infeasible to use global platform functionalities to meet a work unit’s needs (e.g., a

functionality unique to the work unit, an innovative functionality, an extremely quick

response to an identified opportunity or problem, etc.). In such situations, fashioning

and implementing a local platform is more effective and timely. That said, an over-

dependence on local platforms can quickly lead to excessive costs: work units

undertake digitization and digitalization projects to gain functionalities that have

already been built by other work units; and, when reuse tactics are followed,

unforeseen complexities invariably arise when integrating and/or interconnecting

independently-designed digital solutions.

Figure 4-3
Contrasting Global and Local Platforms

• Tailored Solutions
• Innovative Solutions
Global Platform

• Timely Solutions
Local Platform
• More-Easily Implemented Solutions

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

Platforms: Best Practices

It is increasingly accepted that organizations’ platforms, ideally, should be

modularly-designed and that optimal balance should be achieved regarding these

76
platforms being tightly/loosely coupled and being implemented as a global/local

resource. Although platform modularity is a key feature of newly-built and acquired

platforms, most organizations are in the midst of extensive (and expensive) journeys

to re-architect their installed platforms. Achieving an optimal balance in the use of

tight-/loose-coupling is an ongoing endeavor for most organizations – an endeavor

having two overarching design rules:

 If a platform is expected to be frequently adapted, then loose-coupling is

used to incorporate a bias toward dynamism.

 If a platform is expected to be infrequently adapted, then tight-coupling is

used to incorporate a bias toward stability.

Achieving an optimal balance in the use of global and local platforms is an ongoing

endeavor for most organizations. However, most organizations have a bias toward

global platforms, with a few exceptions:

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

 Digitalized functionalities that must be implemented quickly for competitive

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

 Digitalized functionalities that apply unproven solutions or that introduce

novel forms of digitalization should be initially implemented as local
platforms (to contain risk) and then, once proven and stabilized, be
considered for reimplementation as global platforms.

Platforms and the Domains of Digitalization

Today, platforms host most of the capabilities enabling organizations to carry

out day-to-day work activities and undertake competitive actions. This section

77
describes how digital platforms and business platforms have transformed

organizations’ operational, analytical and collaborative domains.

The Operational Domain

Digitalization of the operational domain is directed at two primary aims: event

visibility and channel multiplicity. Event visibility refers to making key events (an

order, a sale, an inventory movement, a shipment movement, a shipment delay,

etc.) and non-events (a consumer leaving without a purchase, an out-of-stock

inventory situation, etc.) known to the individuals and the digitalized solutions taking

action so that appropriate actions can be taken.

Currently available digital technologies have overcome many of the challenges

that previously restricted event visibility. However, it is important to recognize that

event visibility is also affected by cultural practices. If an organization’s work units

are insufficiently incentivized to work together, it can be difficult to get all employees

to dance to the same song. Sales personnel, for example, tend to be rewarded for

sales growth, while manufacturing personnel tend to be rewarded for productivity

and quality control. As a result, manufacturing personnel may decide not to let sales

personnel know about a spike in defect rates – information that the sales unit needs

when interacting with customers. Such issues only intensify with information flows

that cross organizational boundaries. Should a manufacturer let a supplier know the

nuances that underlie customers’ purchasing behaviors? How about if the supplier

also supplies the manufacturer’s prime competitors? Should a component-supplier

let a manufacturer-customer know about an emerging supply chain issue likely to

delay future component shipments? Does your answer change if the manufacturer-

customer could easily switch to other suppliers?

78
 Channel multiplicity refers to ensuring that a sufficient mix of

interconnection channels are available to handle the data, messages and documents

flowing to and from individuals and digital solutions so that a preferred channel is

available for use. Channel multiplicity is particularly important when connecting with

humans, as people tend to develop strong preferences for using specific channels for

different interconnection situations. Consider your own behavior, for instance. Do

you communicate most with others who use the same communication channels (e.g.,

email, texting, phone, etc.) that you prefer? Do you tend to use specific

communication channels for communicating specific types of information (e.g.,

texting for good news, but speaking face-to-face for bad news, or vice versa)?

Figure 4-4 depicts a generic operational platform. Note that the platform hosts

an organization’s primary and support processes, as well as the data captured and

used by these processes. Further, these processes extend externally to connect with

the processes of value stream participants through a mix of interconnection channels.

It is by appropriately tuning these processes and by using appropriate interconnection

channels that key events occurring inside and outside an organization are made

visible to individuals and digital solutions.

79
 Figure 4-4
A Generic Operational Platform

Channel Multiplicity
Global

Channel Multiplicity
Operational
Upstream Database Downstream
Intermediaries Intermediaries

Support
Channel Multiplicity

Processes

Channel Multiplicity
Material &
Component Primary Consumers
Suppliers Processes

The operational domain is especially important for passenger airlines, such as

Delta Airlines.17 Consumers are very concerned with safety, with on-time departures

and arrivals, and with having their in-flight needs met. Not surprisingly, all airlines

pursue the operational excellence value discipline. Figure 4-5 provides a high-level

view of Delta’s operational platform. Operating a heavy schedule of flights across a

mix of aircraft, routes and airports is like choreographing and directing the largest

ballet ever conceived. Unless all employees and all executing digitalized solutions

are collectively able to maintain a close-to-real-time awareness of the thousands of

events occurring each minute, problems are sure to arise.

17
This discussion of Delta’s operational platform is adapted from material in: J.W.
Ross, P. Weill and D.C. Robertson, Enterprise Architecture as Strategy, Boston: Harvard
University Press, 2006.
80
 Figure 4-5
Delta Airline’s Digitalized Operational Platform

Location Flight Employees

Schedule Equipment Customer

Core Data
Maintenance Aircraft Ticket

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

The Analytical Domain

Digitalization in the analytical domain is also directed at two primary aims:

improving decision processes, and accumulating knowledge about these decisions to

improve operational and managerial performance. Organizations amass analytical

capabilities by providing (suitably-trained) employees with easy-to-use tools with

which to access and analyze comprehensive collections of data. Increasingly, subsets

of these same analytic capabilities are provided to employees of other value stream

participants (e.g., a retail chain’s buyers, a supplier’s manufacturing management

team, etc.).

Figure 4-6 depicts a generic analytical platform. Collections of data typically

reside in either a data warehouse (a single, comprehensive archive of organized

data across multiple spheres of work; e.g., marketing, logistics and manufacturing)

81
or a more focused data mart (a smaller archive of organized data focused on a

specific sphere of work; e.g., marketing, logistics or manufacturing). These data

archives are populated from operational databases, from other internal sources, and

from external sources (e.g., market research firms, economic forecasters,

governmental agencies, etc.). Furthermore, these data are most often analyzed to

achieve one or more of the following four purposes: description, diagnosis, prediction

or prescription. The most common analytical tools used in achieving these purposes

are defined in Table 4-2.

Figure 4-6
A Generic Analytical Platform

External
Data Data Ad Hoc Queries
Sources Warehouse
and/or
Data Marts
Predefined Queries
Global
Operational
Database
Diagnosis
Description Statistical Analyses
 Failure
 Events
Other  Success
 Objects
Internal  Event
 Situations
Data Sources occurrences
Math. Modeling
Analytic Purpose

Prediction
 Events Prescription Data Mining
 Outcomes  Optimal actions

Machine Learning

82
 Table 4-2
Common Analytical Tools

Analytic Tool Description

Ad Hoc Data retrieval via user-generated search criteria &
Queries display formats.
Predefined Data retrieval with pre-defined search criteria &
Queries display formats.
Descriptive (organizing and summarizing data to
Statistical
better understand the data) & inferential (confidently
Analyses
drawing conclusions from samples of data).
Combining large amounts of data and sophisticated
Mathematical
algorithms to make accurate predictions and to derive
Modeling
optimal solutions to complex problems.
Discovery of patterns within sets of data that lead to
Data Mining &
insights regarding the relationships amongst these
Machine Learning
data.

The analytical domain is important for organizations tailoring value-units for

consumers - especially for a customer-intimacy company like Netflix that strives to

provide subscribers with a customized, fresh experience each time they access the

Netflix content catalog. Figure 4-7 provides a high-level view of Netflix’s digitalized

analytical platform. Netflix has fashioned a huge data archive from three major

sources: subscriber-provided data (a self-profile and content ratings), content data

(largely put together by Netflix staff), and real-time data streams capturing very-

detailed views of subscribers‘ content-viewing behaviors. By analyzing these data

via numerous proprietary algorithms, Netflix is able to optimize the content

recommendations and viewing experiences provided to each subscriber (increasing

engagement and decreasing cancellation likelihood) and is able to make more-

informed decisions about buying, licensing and producing content.

83
 Figure 4-7
Netflix’s Digitalized Analytical Platform

Subscriber Content
Subscriber Profiles Attributes
Real-Time (genre tags, Core Data
Viewing Subscriber technical data,
Behaviors Content artist data, etc.)
Ratings

Predicting & prescribing a subscriber’s content selections.

Diagnosing & predicting actions of subscriber segments.

Critical
Prescribing content types/amounts for the current content catalog. Analytic
Processes
Prescribing how content should be stored & delivered to provide the
best subscriber experience.

Prescribing content to acquire, license & produce.

The Collaborative Domain

Digitalization in the collaborative domain involves the fabrication of

interaction platforms through which people are brought together virtually, rather

than physically, to jointly accomplish work activities. Such a capability is becoming

increasingly important in today’s highly-competitive, far-flung markets. Often, the

best people to bring together to solve a problem or to tackle an opportunity are

employed by participants across a value stream (see Table 4-3).

84
 Table 4-3
Value Stream Collaboration Opportunities

Collaboration
Description
Opportunity
Employees from manufacturers, distributors & retailers collaborate to
Downstream better understand consumer demand patterns, to develop joint
Processes strategies & tactics for marketing & fulfillment, and to detect & resolve
downstream supply-demand imbalances.
Employees from manufacturers, raw material & component suppliers,
Upstream and upstream intermediaries collaborate to better understand
Processes procurement & production patterns & costs, and to detect & resolve
upstream supply-demand imbalances.
Employees from manufacturers, suppliers, subcontractors, distributors,
Upstream & retailers & logistics providers collaborate to better understand
Downstream transportation demand patterns & costs, to develop joint strategies &
Logistics tactics regarding transportation solutions, and to detect & resolve
upstream/downstream logistics problems.
Employees from manufacturers, suppliers & engineering design firms
Product & collaborate to better understand the nature, timeframes & costs of new
Process Design product/process designs, to develop joint strategies & tactics for
enhancing design processes, and to detect & resolve design problems.

There are two basic types of collaboration arrangements. The first involves

recurrent collaborations where the (more or less) same people work on an ongoing

task (e.g., a marketing group consulting with sales teams, a weekly meeting of a

manufacturer’s plant managers, etc.). Typically, a local collaboration platform is

configured and used to support a recurrent collaboration. The second type of

collaboration arrangement is ad hoc and temporary in nature (e.g., a task force

brought together to accomplish a one-time task). Generally, groups engaged in ad

hoc collaborations use global collaboration platforms, with a group’s interactions

facilitated (initially and perhaps longer) by a collaboration specialist.

Figure 4-8 depicts a generic collaboration platform. Each participant has

access to their own digital resources in addition to the resources provided via the

collaboration platform. The platform contains a data archive that holds data and

documents uploaded by the participants as well as data, messages and documents

that are created as participants interact within the various work spaces provisioned
85
through the platform. Figure 4-8 identifies four such work spaces: messaging and

conferencing, idea processing, joint-work and decision making.

Figure 4-8
A Generic Collaboration Platform

Data
Person Archive

Person
Idea Processing
Messaging &  Generation
Conferencing  Curation
 Refinement

Collaboration
oint Spaces
Person
Joint-Work
 Designing Decision Making
 Problem Solving
 Authoring
Person

Collaboration platforms are especially important for organizations pursuing the

product leadership value discipline, as new product development often requires the

bringing together of dispersed expertise. A nice example of this can be seen with the

exceptional outcome attained in a project undertaken by Boeing-Rocketdyne, the

major U.S. manufacturer of liquid fuel rocket engines, to produce a next-generation

rocket engine.18,19 The project team consisted of eight individuals (a project team

leader, a concept designer, a combustion analyst, two thermal analysts, a

18
A. Malhotra, A. Majchrzak, R. Carman and V. Lott, “Radical Innovation without
Collocation: A Case Study at Boeing-Rocketdyne,” MIS Quarterly, June 2001, pp. 229-249.
19
In 2005, Boeing sold the Rocketdyne Division to United Technologies Corporation,
which sold the Division to GenCorp in 2013, which merged with Aerojet to form Aerojet
Rocketdyne.
86
manufacturability engineer, a CAD (computer-aided design) specialist, and a stress

analyst) from Boeing-Rocketdyne and two partner-companies. These individuals

were located at different geographic locations as a result of a selection process aimed

at getting the very best talent available involved in the project.

The project lasted for ten months with participants devoting less than 15% of

their work time to the project. Participants met physically only twice: six of the

eight participants were able to get together for a project kick-off meeting (that also

included training on the collaboration tools) and all eight members were able to

physically meet for a project-ending celebration. Table 4-4 describes the

collaboration tools made available to the project team. The engine design that was

produced far exceeded expectations, e.g., the rocket’s thrust chamber had only six

parts (compared to the typical 1,200 parts) and a first-unit production cost of

$47,000 (compared to the typical $4,500,000).

Table 4-4
Next-Generation Rocket Engine Project Collaboration Tools

Collaboration Tool Description

Shared work space enabling project team
members to create, comment on, reference links
Internet Notebook to, search & sort entries whose content consists
of text, templates, sketches, images and/or hot
links to desktop applications.
Shared workspace enabling project team
Electronic Whiteboard members to have near-instantaneous access to
the same materials.
Shared data archive enabling project team
Project Vault members to store & access files via a common file
server.
Email Available digital communication channels
Telephone enabling project team members to interact with
Voice Conferencing one another.

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Digital Strategy Formulation

Table 4-5 presents the overarching strategic challenges that need to be

constantly addressed by pipeline organizations’ digital strategists as these strategists

cope with digital disruption. The first of these strategic challenges addresses how to

handle heterogeneity within the consumer community, which is especially important

for this section’s treatment of digital strategy formulation. If distinct consumer

segments exist and if each segment varies significantly in how it relates to value-

units and associated value propositions, then each segment is likely to require its

own business model. While some of these business models might be expected to

demonstrate considerable similarity, others undoubtedly will not. This section’s

treatment of digital strategy formulation focuses on the design and evolution of a

single business model, with this business model targeting either a homogeneous

consumer community or one of the segments of a heterogeneous consumer

community. Most often, digital strategists are involved with formulating and evolving

multiple business models.

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 Table 4-5
Pipeline Organization Strategic Challenges

Strategic Challenges Key Issues

 Have we segmented, through analytics, the consumer
How differentiated is the
community?
consumer community?
 Is a distinctive business model required for each segment?
 How can we enhance our customer value proposition and our
profit model?
How can our current
 Should we deepen & broaden our core capabilities and our
competitive positions be
dynamic capabilities?
improved?
 To what extent can we further exploit the capabilities of value
stream participants?
Can we enter an adjacent  Which adjacent markets are most susceptible for one of our
market by replicating a currently executing business models?
currently-executing  What type of business model modifications would be required to
business model? gain a favorable competitive position in the adjacent market?
Can we create a new  Is it possible to apply our capabilities along with our strategic
market through business partners’ capabilities to create an innovative business model that
model innovation? creates a new niche within an existing market or a new market?
 Can we deter (for some period of time) competitors’ responses to
How can we sustain
our competitive actions?
successful market
 Can we keep our business models two or more steps ahead of
positions?
those of our competitors?

Figure 4-9 provides an overview of the factors driving digital strategists’

deliberations as they deal with the remaining four strategic challenges listed in Table

4-5: deliberations framed by a strategic intent espoused by their organizations’

leadership teams and focused on the four elements of a business model.

89
 Figure 4-9
Factors Driving Business Model Enhancement, Replication & Innovation

 Competitors’ actions
 Adjacent market business
model innovations
 Socioeconomic trends
 Cultural trends
 Consumers’ needs & desires

Strategic Intent

Beliefs about: Business Model Deliberations

Business Model
 Consumers’ needs  Value proposition
Enhancement,
& desires  Profit model
Replication &
 Core capabilities  Core capabilities
Innovation
 Dominant value  Dynamic capabilities
discipline(s)

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

Strategic Intent

A strategic intent represents a leadership team’s effort to make more-

actionable their organizations’ vision and mission statements, which most-typically

are presented in an aspirational and intentionally-vague manner. In essence, a good

strategic vision answers the question: “What kind of organization do we wish to

become?”; and, a good mission statement answers the question: “What must we

do to achieve this vision?” Table 4-6 provides vision and mission statements for

Apple and Walmart.20,21

20
Apple’s mission and vision statements obtained from: http://panmore.com/apple-
mission-statement-vision-statement
21
Walmart’s mission and vision statements obtained from:
http://panmore.com/walmart-vision-mission-statement-intensive-generic-strategies
90
 Table 4-6
Vision & Mission Statements for Apple and Walmart

Vision Statement Mission Statement

We believe that we are on the face of the earth to make
great products and that’s not changing. We are
constantly focusing on innovating. We believe in the
Apple designs Macs, the best
simple not the complex. We believe that we need to own
personal computers in the
and control the primary technologies behind the
world, along with OS X, iLife,
products that we make, and participate only in markets
iWork and professional
where we can make a significant contribution. We
software. Apple leads the
believe in saying no to thousands of projects, so that we
digital music revolution with its
can really focus on the few that are truly important and
Apple iPod and iTunes online store.
meaningful to us. We believe in deep collaboration and
Apple has reinvented the
cross-pollination of our groups, which allow us to
mobile phone with its
innovate in a way that others cannot. And frankly, we
revolutionary iPhone and App
don’t settle for anything less than excellence in every
store, and is defining the
group in the company, and we have the self-honesty to
future of mobile media and
admit when we’re wrong and the courage to change. And
computing devices with iPad.
I think regardless of who is in what job those values are
so embedded in this company that Apple will do
extremely well.

To be the best retailer in the hearts and minds of Saving people money so they
Walmart
consumers and employees. can live better.

A good strategic intent answers the question: “What must we do specifically

and now to achieve our vision and mission?” In doing so, a strategic intent provides

deliberating digital strategists with a sense of purpose, direction, discovery and

destiny. Invariably, as indicated earlier in Figure 4-9, a strategic intent likely involves

expressions of consumers’ near-term needs and desires and of the value-disciplines

to be embodied for these needs and desires to be met.

Business Model Enhancement, Replication and Innovation

Digital strategists’ deliberations focus on discovering and shaping business

model adaptations likely to strengthen current market positions or to establish

positions in new markets. By far, most formulated competitive moves are taken to

strengthen a current market position.

Business model enhancement, replication and innovation involve distinct

competitive pursuits:
91
  Business Model Enhancement: incremental changes are made to one or
more of the four elements of business models.

 Business Model Replication: a business model proven successful in one

market is applied within an adjacent market; most often, this adjacent
market is characterized by value-units, consumers and/or value streams
similar to the market where the business model has demonstrated success.

 Business Model Innovation: Radical changes are made to one or more of

the four elements of business models or a novel configuration of these
elements is fashioned; this novel business model is typically implemented
within a newly-defined niche of an existing market or is used in creating a
new market.

Despite the differing trajectories reflected in business model enhancement,

replication and innovation, similar types of adaptations (summarized in Table 4-7)

tend to be observed.

Table 4-7
Business Model Adaptations

Value Propositions Profit Models

 Satisfy unmet needs & desires of current
consumers about a value-unit and/or the
delivery of the value-unit.
 Satisfy anticipated needs & desires of
current consumers about a value-unit
and/or the delivery of the value-unit.
 Identify new consumers or a more-finely
segment of current consumers and satisfy
the needs & desires of this newly-defined
consumer segment.
Core Capabilities
 Add new digitalization capabilities.
 Enrich the functionality of currently-
executing platforms.
 Add new platforms.
 Harden platforms operating in
environments benefiting from stability.
 Modularize platforms operating in
environments benefiting from agility.
 Increase current revenue streams.
 Add new revenue streams.
 Reduce cost structures.
 Identify new pricing mechanisms for
generating revenue by delivering value-
units to consumers.
 Eliminate unprofitable or less-profitable
revenue streams.
Dynamic Capabilities
 Modify assessment frequencies.
 Modify environment scanning reach &
range.
 Modify digital strategists’ offensive-
defensive orientation.
 Modify composition of the digital-strategist
group.

For the most part, the profit model adaptations are quite straightforward. The

one profit model adaptation that might not be readily apparent is that involving

pricing mechanisms. A pricing mechanism refers to the means by which a value-

92
stream participant captures its share of the value being created by the value stream.

A variety of value-capture mechanisms exist, with the most common defined in Table

4-8. Often, a business model applies multiple value-capture mechanisms.

Table 4-8
Different Value-Capture Mechanisms

Pricing
Price determined as/by …
Mechanism
Cost-Plus A percentage on top of cost of producing and delivering a value-unit.
Competitor-Based Calibrating against competitors’ prices for the same or similar value-unit.
The number & sophistication of the features provided in a value-unit
Multi-Tiered
variant.
Freemium A multi-tiered mechanism where the base (first-level) tier is free.
Bundling The nature of value-unit aggregations provided to consumers.
Segmented The producer for specific customer segments.
Pay-What-You-Want The consumer.
Fenced The consumer selecting a price-segment and the producer after fencing
Pay-What-You-Want the consumer into this segment.
Demand The real-time demand for a value-unit.
Auction An auctioning mechanism.
The joint cost of an installed-base (e.g., the razor) and the use of this
Installed-Base
installed-base over time (e.g., the razor blade).
Futures Contracting The predicted demand (at a future point-in-time) for a value-unit.

The modifications to the dynamic capabilities element are not quite as

straightforward. Four types of modifications were listed in Table 4-7:

 Assessment frequency – the prescribed frequency by which digital

strategists deliberate on a business model or on particular aspects of a
specific business model; and, the continuing-suitability of certain business
models and certain business model elements.

 Environmental scanning reach and range – the variety of entities (range:

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

 Offensive/defensive orientation – whether the primary objective of the

digital strategists, as a group, is to strengthen or to protect current
competitive positions.

 Composition of the digital strategists group: the knowledge domains (e.g.,

value disciplines, core capabilities, cost structures, etc.) and constituencies
93
 (e.g., producer subunits, suppliers, intermediaries, consumers, etc.)
influentially represented during deliberations.

Each of these modifications produces significant changes in a digital strategy group’s

collective awareness of the need for and nature of business model adaptations and

the effort (time, complexity and cost) associated with digital strategists’ individual

and group deliberations.

Digital Strategy Formulation in Practice

Digital strategies implemented by Finnair and by UPS Supply Chain Solutions

(UPS-SCS) are illustrative of the thought-processes exercised by digital strategists.

In addition, these examples illustrate two not-uncommon trends regarding

organizations’ digital strategies: embracing customer intimacy after having

established a reputation based on operations excellence, and actively involving

consumer communities in co-creating a value proposition. Table 4-9 summarizes key

business model adaptations for the Finnair and UPS-SCS episodes.

Table 4-9
Business Model Adaptations: Finnair & UPS Supply Chain Solutions

Organization Finnair UPS Supply Chain Solutions

Value  Offer long-haul travelers
Proposition innovative & valued services
 Higher-margin market
Profit Model segment
 Institutionalized social media
Core use
Capabilities  Individualized social media
use
 Co-creation of new services
Dynamic with customer community
Capabilities  Outward-looking
organizational culture
 Customized, complex solutions
 Quick implementations
• Higher-margin market segment
• Low configuration costs
• Low implementation costs
 Modularized solution services
 Modular architecture
 Educate digital strategists on
modular architecture
 Deploy cross-functional teams to
integrate marketing, sales &
digitalization specialists
 Co-creation of digitalized
solutions with customer
 Modify investment criteria for
digitization & digitalization

94
Finnair22

Finnair is the world’s oldest, midsize airline with a unionized labor force. Like

similar airlines, Finnair embodied the operations excellence value discipline.

However, the company’s high fixed-costs and the influx of low-cost short-haul

competitors had seriously eroded its competitive position – particularly within short-

haul markets.

Exploiting the airline’s geographic advantage (the Helsinki hub provides one of

the fastest routes between Europe and Asia), Finnair’s leadership team had chosen

in 2009 to focus the airline on long-haul Asian routes – a market niche within which

Finnair was relatively unknown. Consequently, a series of competitive actions were

taken to strengthen the airline’s position in the long-haul Asian market, with a key

target area being the creation of innovative services to enrich the airline’s value

proposition for the long-haul consumer.

Finnair’s use of social media technology (SMT) has played a key role in

engaging the consumer community in co-creating these new services - and in the

process enhancing the airline’s image with this consumer community. Heavy usage

has occurred around blogging, Facebook and Twitter, with special attention given to

integrating customer interactions across these SMTs. Importantly, both institutional

(structured, tightly-moderated interactions orchestrated by Finnair employees) and

individualized (unstructured, loosely-moderated interactions with individual

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

22
This material is adapted from: S.L. Jarvenpaa and V.K. Tuunainen, “How Finnair
Socialized Customers for Service Co-Creation with Social Media,” MIS Quarterly Executive,
September 2013, pp. 125-136.
95
meaningful ideas for new services have been generated, two of which were

implemented in 2013: a book-swapping station at the Helsinki airport, and the

availability of a high-quality vegetarian meal option (for business-class and economy

travelers) on all long-haul flights.

UPS-SCS23,24

UPS is the parent company of UPS-SCS. It was formed in the early 1990s, is

positioned in a mature market for transportation solutions, and has a strong culture

rooted in the operations excellence value discipline. UPS-SCS, on the other hand,

was established in order to pursue a differentiation strategy by developing a wide

variety of specialty services and offering its B2B consumers customized, complex and

comprehensive supply chain solutions.

In the early 2000s, the UPS-SCS leadership team realized that its growth was

about to hit a brick wall. Two factors explained this portending crisis. First, low-cost

competitors had entered the UPS-SCS competitive space and were eating away at

the low-hanging-fruit, i.e., less-complex, less-comprehensive, but profitable

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

complex, comprehensive solutions were proving to be unprofitable because of the

high-cost and lengthy lead-time required to design and implement a solution.

The leadership team’s strategy to address this situation involved three

objectives:

23
M. Lewis, A. Rai, D. Forquer and D. Quinter, “UPS and HP: Value Creation through
Supply Chain Partnership,” Case 9B07D002, Ivey Management Services, 2007.
24
A. Rai, V. Venkatesh, H. Bala and M. Lewis, “Transitioning to a Modular Enterprise
Architecture: Drivers, Constraints and Actions,” MIS Quarterly Executive, June 2010, pp. 83-
94.
96
  Operational B2B readiness – provide the capability to quickly integrate UPS-
SCS services into a customized solution and to seamlessly interconnect this
solution with a customer’s business platforms.

 Internal services awareness – increase the working knowledge of UPS-SCS

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

 Customer familiarity – increase the working knowledge of UPS-SCS sales

employees and solution designers about current/potential customers and the
idiosyncrasies that distinguish each customer from its competitors.

Achieving these objectives involved building a number of platforms: a modularized

operational platform hosting and executing the UPS-SCS portfolio of digitalized

solutions; analytical platforms that organized and enabled easy access to information

about services, solutions and customers; and, collaboration platforms enabling

solution designers, sales staff and customers to jointly configure and implement

solutions.

Sustaining Competitive Positions

When competitive actions strengthen an organization’s competitive position,

the organization ideally desires to sustain the gained competitive advantage for as

long as possible (the fifth strategic challenge listed earlier in Table 4-5). For example,

after the successful implementation of a first-mover customer loyalty program aimed

at identifying and retaining high-value customers, increases in market share and

sales revenues are likely to be realized. However, if competitors are able to quickly

imitate the loyalty program, then these initial gains are likely to dissipate as

competitive parity returns to the market.

Digital disruption is making it more difficult than ever to sustain a newly-gained

competitive advantage. As many, if not most, of the digital platforms and business

platforms enabling competitive advantages are readily available today, competitor

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imitative responses occur promptly and frequently. Further, as these imitative

responders can learn from the innovator’s actions, these responses are often better

and less costly.

The tactic taken most often to sustain a newly-gained competitive advantage

is to construct one or more barriers to competitive retaliation. The less-

penetrable these erected barriers are, the longer the competitive advantage can be

sustained. Piccoli and Ives categorize these barriers into four types (see Table 4-

10):25 digital resources, complementary resources, project management capabilities

and preemption.

Table 4-10
Barriers to Competitive Retaliation

Barrier Characteristics of a Strong Barrier

 Unique and/or rare
Digital Resources  Not available from a third-party
 Difficult, time-consuming and/or costly to build from scratch
 Unique and/or rare
Complementary
 Not available from a third-party
Resources
 Difficult, time-consuming and/or costly to build from scratch
Project  Complexity of an imitative response
Management  Difficult, time-consuming and/or costly to develop needed
Capabilities capabilities
 High consumer switching costs
 Difficult, time-consuming and/or costly to identify & attract
Preemption
value-stream participants and to build the platforms to
coordinate value-stream data, document & information flows

The digital resources barrier is based on an organization’s investment in

unique or rare digital/digitalized assets and capabilities. For example, if an

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

25
G. Piccoli and B. Ives, “IT-dependent Strategic Initiatives and Sustained Competitive
Advantage: A Review and Synthesis of the Literature,” MIS Quarterly, December 2005, pp.
747-776.
98
stream upstream/downstream platforms and if a gained competitive advantage is

dependent on such a capability, then it would likely take a rival a prolonged period

of time to put in place similar platforms. Just such a barrier was invoked when

Walmart pioneered vendor-managed inventory with Procter and Gamble. Walmart

provided Procter and Gamble with the ability to access Walmart point-of-sale data in

real-time so that Procter and Gamble could monitor Walmart’s store-level inventories

and replenish stock on an as-needed basis.

The complementary resources barrier is based on requirements for unique

or rare non-digital resources in establishing a digitalized competitive advantage.

Harrah’s, for example, has been a pioneer in using analytics to build and exploit

superior customer relationships. However, Harrah’s also undertook a radical

organizational change when it launched its customer-analytics strategic initiative.

Casinos in a chain traditionally operate independent of one another. With the

organizational change, Harrah’s introduced reporting structures and incentives to

build an enterprise-wide customer relationship management culture where customers

are owned by the corporation rather than by a specific casino, and where employees

are expected (and rewarded for doing so) to make decisions on the basis of customer-

related analytics.

Digitalized competitive actions are often implemented as large, complex and

risk-laden projects involving a large number of people holding a variety of skills.

Such projects can be extremely difficult to complete on-time, on-budget and as

specified. The project management capabilities barrier involves the presence of

needed project management capabilities. For example, when Amazon launched its

B2C retail bookstore, a large number of complex activities needed to be carried out

99
well and in a highly-coordinated fashion: building the needed digital and business

platforms; putting in place a powerful and reliable technical infrastructure to host its

online store; establishing efficient, effective and reliable physical operational and

managerial processes (e.g., warehouse operations, order packing and shipping,

customer service, processes, etc.); and, negotiating relationships with value stream

participants (e.g., book publishers and distributors, logistics providers, financial

services firms, etc.). Any competitor would need to possess correspondingly-high

levels of project management capabilities.

A preemption barrier limits competitors’ opportunities and incentives to

undertake retaliatory action. One such barrier involves customer switching costs,

or the costs to be borne by a consumer choosing to move to a competitor’s products

and/or services: learning a new set of product/service interface actions and rules,

changing work practices, out-of-pocket expenses, etc. When substantial switching

costs exist, the competitor must not only induce consumers to switch, but also

compensate the consumer for borne switching costs. For example, while eBay has

faced stiff competition from other auction sites, a key switching cost that works in its

favor is that reputations built on eBay are lost. A second type of preemption barrier

involves the anticipated effort required to identify and attract new value stream

participants and to assimilate these new participants within a value stream’s

platforms. For example, Dell’s success in negotiating the participation of other firms

in its build-to-order pipeline ecosystem proved to be a dominating preemption

barrier.

How effective are these barriers to competitive retaliation in the face of digital

disruption? With competitors reacting faster and faster and with markets increasingly

100
susceptible to new entrants, about the only things that can be said with confidence

are that the length of time any competitive gain can be sustained is growing shorter

and that the best defense is to take the offense; that is, take a second competitive

action before the competition can react to the initial action.

A Recap and Look Ahead

This chapter has examined how digitalization has transformed pipeline

organizations’ digital strategies and digital strategy formulation processes. However,

one critically important topic was not discussed – today’s reality that many, if not

most, of the digitization and digitalization capabilities being applied by both pipeline

organizations and network organizations in taking competitive moves and in

executing business models are externally-sourced, rather than internally-sourced.

Explanations of why this is the case and of the strategic implications of this

phenomenon are covered in the next chapter.

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 Chapter 5. Digital Strategy and the External Sourcing of Capabilities

Pipeline organizations rarely compete solely through their own capabilities.

Instead, they leverage the capabilities of suppliers, service providers, intermediaries,

strategic partners and consumers. While this has always been the case, the two

drivers of digital disruption – ever-accelerating advances with digital technologies

and globalization – have dramatically enhanced the availability, ease-of-

implementation, reliability and cost-attractiveness of externally-sourced capabilities.

As an illustration of what is possible today, consider the publisher of this book:

Legerity Digital Press (LDP). Owned, managed and operated by five individuals

(contributing intangible assets but little else), LDP has no employees and few assets

(e.g., an acquired digitalized accounting system, personal productivity tools, etc.),

other than the digital books that have been published. The vast majority of the

resources applied across LDP’s value stream are provided by external parties: the

digital platform hosting LDP’s website, the digitalized platform hosting LDP’s B2C

storefront, the digitalized platforms hosting payment and banking processes, the

digitalized platforms producing hard copies and course packs, the digitalized

platforms providing sales channels to university books stores and to libraries, and a

provider of advanced accounting and tax services.

While the experiences of entrepreneurial startups like LDP are clearly different

from those of mid- and large-sized organizations, an ever-increasing portion of the

capabilities enabling organizations’ business models have been (or are being)

externalized – that is, handled (in full or in part) by other organizations. The

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

102
transferring ownership and decision rights regarding a capability, the assets used in

executing the capability, and/or the management of the capability from inside an

organization’s boundary to outside this boundary.

Capabilities are externalized in order to accomplish work activities quicker,

more effectively, more efficiently and/or less costly. By making measured decisions

about which capabilities to externalize and the governance of these externalized

capabilities, significant improvements in organization performance can occur. This

chapter describes how external sourcing is brought into digital strategy formulation

by covering the following topics:

 Externalizing Organizations’ Capabilities

 Tactics for Lessening Clients’ Dependence on Sourcing Providers

 External Sourcing and Digital Strategy Formulation

 Achieving External Sourcing Agility at Commonwealth Bank of Australia

Externalizing Organizations’ Capabilities

Organizations apply a broad array of capabilities in developing, marketing,

producing, selling, delivering and supporting the value-units offered to consumers.

It is useful to recognize that this broad array of capabilities can be categorized into

three capability-sets, each of which focuses on a value discipline: operations

excellence, customer intimacy and product leadership.26,27 These capability-sets,

described in Table 5-1, drive distinct operational and managerial processes, benefit

from distinct orientations, and have distinct underlying economics. Because of these

26
M. Treacy and F. Wiersema, “Customer Intimacy and Other Value Disciplines,”
Harvard Business Review, January-February 1993, pp. 84-93.
27
J. Hagel, III, Out of the Box, Boston: Harvard Business School Press, 2002.
103
differences, it can be challenging for any organization to execute all three capability-

sets exceptionally well. As a result, organizations tend to be organized as three

separate units (each focused on a specific value discipline) that are coordinated so

as to operate as a single enterprise. Invariably, though, these units’ distinctive

incentive systems and control systems bump into and work against one another.

Table 5-1
Three Distinct Capability Sets

Value Discipline Capability Set

Operations
Customer Intimacy Product Leadership
Excellence
Value Proposition
Research and
Development
Key Production Development
Operational Consumer
Purchasing Value-Unit Launch
& Managerial Development
Processes Logistics New Market
Consumer
Development
Retention
Growth
Organization Quality Innovation
Orientation Consumer
Focus Cost
Responsiveness
Adaptation

Underlying Economies Economies Economies

Economics of Scale of Scope of Speed

Executive leadership teams thus face a complex trade-off. Should they

unbundle – that is, fully or partially externalize - one or two of these capability-sets

so that their enterprise has a singular strategic/operational focus? Or, should they

maintain all three units within their organization’s boundaries in order to avoid the

challenges that arise in coordinating work across multiple organizations? If the

decision process of unbundling is handled well and if externalized capabilities are

governed well, clear benefits can arise (see Table 5-2).

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

Benefits How Benefits Are Realized

 Provider exploits economies-of-scale.
Operational  Provider uses leading-edge digital resources in enabling offered
Efficiency & capabilities.
Effectiveness  Provider embeds leading-edge technical, business and managerial
expertise within offered capabilities.
 Provider owns the digital resources enabling offered capabilities.
Leverage
 Client transfers to the provider ownership of some (or all) of the digital
Provider’s Capital
resources previously used to enable the externalized capabilities.
 Client replaces fixed costs with variable costs.
 Provider exploits economies-of-scope & economies-of-speed.
Adaptive &
 Provider uses leading-edge digital resources in enabling offered
Entrepreneurial
capabilities.
Agility
 Provider embeds leading-edge technical, business & managerial expertise
within offered capabilities.
 Provider exploits economies-of-scale, economies-of-scope & economies-
of-speed.
 Provider uses leading-edge digital resources in enabling offered
Innovation
capabilities.
 Provider embeds leading-edge technical, business & managerial expertise
within offered capabilities.

These benefits can be especially attractive when an offshore provider, rather

than an onshore provider, is used. An offshore provider is located in a different

country than the client, and an onshore provider is located in the same country as

the client. Offshore providers can provide appealing rate structures (attributed to

low labor rates, tax incentives, etc.), as well as access to scarce skill-sets, and often

exhibit exceptional production/delivery capabilities as a result of their exploitation of

economies-of-scale, economies-of-scope and economies-of-speed. Additionally,

organizations that aggressively pursue globalization are often able to leverage their

relationships with offshore providers to enrich their understandings of other

countries’ business and social cultures.

The benefits from externalizing capabilities do not come without risk (see Table

5-3), and these risks only intensify when offshore providers are used. Why do these

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

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because an off-shore provider’s employees can exhibit linguistic and cultural

differences relative to a client’s employees, communication can prove troublesome

with seemingly subtle differences in interpretations leading to severe and unexpected

problems. Second, over time and all too often, a client externalizing a capability can

become overdependent on the provider, as internal expertise regarding the capability

is lost (because internal staff is transferred to the provider, assigned other internal

roles or let go). As a consequence, the client’s capabilities to govern the provider’s

performance and to incorporate the externalized capability within digital strategizing

are both reduced. Client-provider misunderstanding and client overdependence on

a provider also exacerbate the remaining risks listed in Table 5-3. Of course, many

other factors (e.g., technical, contractual, legal, political, etc.) also contribute to

these other risks.

Table 5-3
Potential Risks Arising from the External Sourcing of Capabilities

Client Risks How Risks Unfold

Client-Provider  Failures of client & provider managerial/operational staffs to understand
Misunderstanding each other’s values, perspectives, objectives, concerns, directions, etc.
Overdependence
 Loss of internal capability expertise and of attention.
on Provider
 Expected cost reductions not fully realized and those that are realized
Inadequate
dissipate over time.
Efficiency &
 Externalized capabilities and the execution of these capabilities are
Effectiveness
insufficiently enhanced over time.
Inability to  Provider fails to refresh the digital resources enabling externalized
Leverage capabilities.
Provider’s Capital  Client allows transferred digital resources to reappear internally.
 Provider fails to respond to best-practice adaptations regarding
Inadequate externalized capabilities.
Adaptive Agility  Provider fails to transfer best-practice knowledge regarding externalized
capabilities to client.
 Provider fails to maintain leading-edge expertise regarding externalized
Inadequate
capabilities.
Entrepreneurial
 Provider fails to transfer leading-edge expertise regarding externalized
Agility
capabilities to client.

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Tactics for Lessening Clients’ Dependence on Sourcing Providers

A particularly troublesome concern whenever capabilities are externalized is

the threat of becoming overdependent on the sourcing provider. Best practices

aimed at forestalling provider-overdependence include:

 Maintaining internal expertise regarding externalized capabilities.

 Enlarging the set of providers with whom capabilities are externalized.

 Establishing effective governance of externalized capabilities.

Among these, the maintenance of internal expertise is most important because it’s

absence precludes the other two practices. Today, the two tactics most commonly

used to enlarge the set of providers are multisourcing and crowdsourcing, and they

are described in the remainder of this section. Tactics relating to governance are

covered in the next section.

Multisourcing

Multisourcing refers to contracting with multiple providers rather than a

single provider. Initially, this tactic involved a client separating the capabilities to be

externalized into relatively independent sets, and then using different providers for

each of these capability-sets. Note, however, that a threat of overdependence

remained. Over time, multisourcing has evolved to become much more

sophisticated, with current best practices advocating:28

 A capability-set to be externalized is modularized, such that each of the

modules can be optimized without considering the modules (of this same

These steps are derived from: B.A. Aubert, C. Saunders, C. Wiener, R. Denk and T.
28

Wolfermann, “How Adidas Realized Benefits from a Contrary IT Multisourcing Strategy, MIS
Quarterly Executive, September 2016, pp. 175-194.

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

 Providers, possessing comparable capabilities, are identified as suitable

candidates for handling the capability-set to be externalized.

 Multiple providers are then selected to handle a subset of each of these

modules, ensuring that considerable overlap occurs in the nature of the
modules assigned to the providers.

 Provider assessment and reselection procedures are regularly undertaken.

While such practices do introduce increased managerial overhead, the benefits are

many: reduced operational and strategic risks, greater likelihood of finding the best-

fitting provider for a module (or set of modules), and sustained competition among

the providers (e.g., price, quality, responsiveness, reliability, innovativeness, etc.).

A further twist on multisourcing involves incorporating a long-tail perspective.

Here, the selection of providers to handle the externalized capabilities “… combines

a few key partnerships with a dynamically changing and unrestricted number of

smaller contracts with other suppliers.” 29 This long-tail aspect thus embraces and

fosters a flow of new providers offering new capabilities to drive the client’s adaptive

and entrepreneurial agilities.

Crowdsourcing

Crowdsourcing involves externalizing a capability to a community of

individual agents, more popularly referred to as the wisdom of the crowd. The

fundamental idea of crowdsourcing is that a crowdsourcer proposes to a community

of potential contributors the voluntary undertaking of a task that consists of or is

enabled by the capability being externalized. Most often, crowdsourcing reflects a

N. Su, N. Levina and J.W. Ross, “The Long Tail Strategy for IT Outsourcing,” Sloan
29

Management Review, Winter 2016, p. 82.

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partial, temporary externalization of a capability. Community members contribute to

task accomplishment via a collaboration platform.

The power of crowdsourcing lies in aggregating and integrating knowledge

from diverse, independent contributors. These individual contributors bring with

them personal knowledge and social information, i.e., information formed through

exposure to the contributions of other community members and these members’

expressed confidence in their contributions. When personal knowledge is weak,

people tend to rely more on social information. But, overdependence on social

information (which can be systematically-biased if a community’s members share

common values, backgrounds and experiences) can lead to overconfidence and

groupthink. For this reason, crowdsourcing tends to produce the highest quality

outcomes when the interacting contributors hold diverse sets of personal perspectives

and knowledge.

There are two basic types of crowdsourcing: collaboration and tournament. In

collaboration-based crowdsourcing, contributors collectively create a single task

outcome. Usually, the community collectively generates ideas, selects the most

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

outcome. By contrast, tournament-based crowdsourcing involves community

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

solutions. The crowdsourcer then selects one of these contributed solutions, or

perhaps a few of the solutions, in exchange for financial or non-financial

compensation. Tournament-based and collaboration-based crowdsourcing can be

combined, e.g., by first engaging a community to submit individual solutions, and

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then collectively engaging the community to evaluate the individually-submitted

solutions and to refine the best of these into a final task outcome.

Table 5-4 defines three common crowdsourcing arenas. Many organizations

have applied crowdsourcing to generate innovative ideas. Most often, this arena finds

an organization (for example: Dell, Finnair, LEGO, Nestle and Starbucks) engaging a

consumer community through social media to generate ideas for enhancing a value

proposition or to extend a product line. But other communities can be targeted, as

well. For example, Zara, the Spanish clothing retailer, targets its internal community

of retail store staff to generate a constant stream of ideas regarding fashion trends -

ideas gleamed from the staff members observing customer behaviors and talking

with customers.

Table 5-4
Three Crowdsourcing Arenas

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

The second crowdsourcing arena targets a community of skilled-individuals to

solve a problem or to handle a recurring task. Notable examples of the former

objective are the tournaments established by Netflix to produce a next-generation

recommendation engine and by NASA to design a laundry system for the

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International Space Station. Many examples of the later objective exist, especially

with regard to software coding and Big Data analytics.

Prediction markets, the third crowdsourcing arena, targets broad, diverse

communities to predict events or outcomes. While early uses were directed at

election campaigns and sports contests, business organizations (such as Google, Ford

and Best Buy) are realizing considerable value from prediction markets in areas as

diverse as forecasting the sales of about-to-be-introduced video games or songs,

filtering the ideas about to enter a new product development process, designing and

selecting between marketing campaign themes, and selecting projects to be funded.

Prediction markets operate in a manner similar to financial stock markets:

 A question is posed to participants (e.g., “Do you wish to buy specific

stock?”).

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

 Participants receive almost instantaneous feedback on how their opinions

compare and contrast with those of other participants (e.g., the current
market price for the stock).

Governing the External Sourcing of Capabilities

Table 5-5 describes the challenges that are confronted in the design of the

governance systems used with externalized capabilities. Two key insights should be

gleamed from this table. First, the pragmatic purpose in externalizing a capability is

to externalize the work activities (that is, the operational and managerial processes)

enabled by the capability. As work activities are far more tangible than are

capabilities, work activities tend to be the focus of governance systems. Second,

these challenges underscore the importance of building and then maintaining internal

expertise regarding a to-be-externalized capability – and, accordingly, internal

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expertise of the work activities enabled by an externalized capability. If a client’s

employees do not possess deep understandings of a work activity, low likelihoods

exist that these employees would be able to negotiate an effective contract with a

provider and to nurture a meaningful trust between themselves and the provider’s

employees carrying out the work activity.

Table 5-5
Challenges in Governing an Externalized Capability

Challenge Description
Codifying the Specifying what is to be done, how it is to be
Understanding Work Activity done and expected performance outcomes
of a
Work Activity Monitoring the Observing what is being done, how it is being
Enabled by Work Activity done and performance outcomes
Externalized Devising Metrics
Capabilities Measuring what is being done, how it is being
of Work Activity
done and performance outcomes
Performance
Client employees and provider employees:
 understand what is expected of one
another
Developing Trust between  are confident that each will perform their
Client Employees & respective work tasks in an ethical,
Provider Employees competent & timely manner
 are confident that each will adapt to
unexpected situations in a manner
consistent with relationship objectives.

In devising a governance system for an externalized capability, it is critical to

recognize that all external-sourcing engagements focus on one, two or three goals:

 Lowering a capability’s cost structure.

 Improving the quality of the capability.

 Introducing innovation into the capability.

What varies across arrangements – hence, what varies in the governance systems

being applied - is the relative importance (and presence) of these three goals.

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 Governance system designs for externalized capabilities can be placed on a

tight-governance/loose-governance continuum (see the top half of Figure 5-1). This

is important, as the design used affects the goals realized through an engagement:

tight-governance works best for cost and quality goals, while loose-governance works

best for quality and innovation goals. Of course, engagements rarely strive to

achieve a cost, quantity or innovation goal. As a result, most engagements tend to

involve aspects of both tight-governance and loose-governance (i.e., tight-

governance is applied to some work activities, loose-governance is applied to other

work activities, and more-nuanced governance designs are applied to yet other work

activities).

Figure 5-1
Tight-Governance and Loose-Governance Designs

Tight-Governance Loose-Governance

Cost-Focus Quality-Focus Innovation-Focus

 Lengthy Contract
 Short
 Detailed  Broad
Administrative Costs
High Low

People Costs
Low High

Table 5-6 contrasts the natures of tight-governance and loose-governance.

Tight-governance, or compliance monitoring, is characterized by a constant,

detailed and deep visibility into how a work activity is being carried out and the extent

to which a comprehensive set of negotiated obligations is being met. If both the

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client and the provider have digitalized their operational business processes, such a

visibility is relatively straightforward to implement and is accompanied by associated

governance-related costs that are recovered through a lowered risk exposure. With

loose-governance, or intent monitoring, the increased discretion given to the

provider inherently increases this risk exposure – an exposure managed

(accompanied by associated costs) through the client-provider relationship and by

regularly assessing whether or not an engagement continues to prove beneficial for

both the client and the provider. As indicated in the bottom half of Figure 5-1, the

natures of the costs borne with tight-governance and loose-governance are quite

distinct.

Table 5-6
Attributes of Tight-Governance and Loose-Governance Designs

Tight Governance Loose Governance

(Compliance Monitoring) (Intent Monitoring)
Monitoring Precise execution of well- Meet agreed-on overall
Philosophy specified work activities performance outcomes
Decision Making Defined standards of
Joint decision making
Philosophy execution
 Client-provider oversight board
 Client-provider management
Governance Service Level Agreements
team
Mechanisms (SLAs)
 Client engagement manager
 Client-provider execution team

Detailed specifications of
Aggregate specifications of
Metrics the tasks and outcomes to
work-related outcomes and risks
be monitored and reported
Specific transactions and
Visibility Rights Work-related outcomes
events
Access Rights Data Knowledge

External Sourcing and Digital Strategy Formulation

External sourcing influences the deliberations of digital strategists in numerous

ways. Consider, for example, the following questions:

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

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 advantageous competitive positions?

 Realistically, how good are we at executing and continuously enhancing

these capabilities?

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

 Are some of these capabilities strategically more important than others?

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

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

of capabilities?

 Would we deliver better value to consumers (and to stockholders) if we only

hosted internally those capabilities critical to our gaining and sustaining
competitive advantages and relied on best-of-class providers to host most
(perhaps all) other capabilities?

As stated earlier, such deliberations are increasingly resulting in organizations

choosing to externalize many, if not most, of the capabilities enabling business

models.

As organizations’ digital strategists and leadership teams become comfortable

with the idea of externalizing capabilities to arms-length providers (via tight-

governance) and to strategic partners (via loose-governance), strategic opportunities

may arise where an organization’s internal capabilities are recognized as being world

class and become the basis of a new business model. If a manufacturing organization

has developed a world-class inventory management capability, why not take over its

suppliers’ or customers’ inventory processes (referred to as vendor-managed

inventory) or offer this capability to other manufacturing organizations? If a

hospitality organization has developed world-class customer support capabilities, why

not spin off a subsidiary offering this capability to other companies?

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 Digital strategists today find themselves regularly considering whether or not

internally-hosted capabilities should be externalized, whether externalized

capabilities should be brought back inside the organization, and whether or not

internal, world-class capabilities should be offered to other organizations. More than

ever before, organizational boundaries seem to be in an almost perpetual state of

flux – a state of flux incessantly driven by the continued advances occurring with

digital technologies and by the forces of globalization.

Digital Strategy Formulation

Figure 5-2 provides an overview of how the external sourcing of capabilities

influences digital strategists’ deliberations. The key element introduced in this Figure

is an explicit categorization of capabilities within the operant strategic intent:

 Strategic core capabilities – the capabilities that lie at the heart of an

organization’s competitive advantage.

 Peripheral core capabilities – the capabilities that are necessary for an

organization to gain and maintain its competitive positions, but that are not
a source of competitive advantage.

 Commodity capabilities – the capabilities that are required or are

otherwise beneficial for an organization to operate and are readily available
from external sources, but do not contribute to competitive positions (aside
from their absence).

Strategic core capabilities are seldom considered for external sourcing – and only

when a trusted world-class provider exists that is able to outperform the organization

now and into the future. Peripheral core capabilities should always be candidates for

external sourcing – aside for capabilities for which an organization demonstrates

word-class performance. Commodity capabilities should be externally-sourced in the

absence of a strong business case for not doing so.

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 Figure 5-2
Influence of External Sourcing of Capabilities on Digital Strategizing

 External sourcing of capabilities

by competitors
 External sourcing of capabilities
in adjacent markets
 Consumers’ beliefs & preferences
about the external sourcing

Strategic Intent
Business Model Deliberations
Beliefs regarding Business Model
 Value proposition
capabilities Enhancement,
 Profit model
 Strategic core Replication &
 Core capabilities
 Peripheral core Innovation
 Dynamic capabilities
 Commodity

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

With digital disruption, it is important to recognize that today’s peripheral core

capabilities may very well become tomorrow’s strategic core capabilities or

tomorrow’s commodity capabilities. (Similar statements could just as well be said

about strategic core capabilities or commodity capabilities.) Why do we see, over

time, movements in organizations’ core capabilities across these three categories?

Four explanations should immediately come to mind:

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

 Existing participants regularly leave markets, while new participants

regularly appear.

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

 Existing digital technologies incessantly improve, but eventually get replaced

by technological innovations providing lower costs, improved performance
and new capabilities.

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Business Model Adaptations

Table 5-7 lists the main pathways through which the external sourcing of

capabilities contributes to organizations’ business model adaptations. Most of these

adaptations are quite straightforward and, hence, are not discussed. However, the

adaptations regarding value propositions may benefit from some elaboration.

Table 5-7
Business Model Adaptations Associated with External Sourcing

Value Propositions Profit Models

 Exploit provider capabilities to increase

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

Core Capabilities Dynamic Capabilities

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

First, consumers are heard to voice a bias against the external sourcing of

capabilities – perhaps most commonly observed with customer support processes,

but extending as well to consumers’ preferences regarding external sourcing in

general. As a consequence, insourcing a previously-externalized capability may serve

as an effective competitive move – especially when an organization has begun to

embrace the customer intimacy value discipline and/or if most competitors have

externalized the capability.

Second, an organization’s proximity to innovative upstream and downstream

ecosystems is critical for the organization to demonstrate agility in modifying value

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propositions. Employees directly in touch - physically and, most importantly,

culturally - with consumers and with ecosystem participants are simply far better

able to identify, incorporate and act upon significant events and trends. As a

consequence, it is not uncommon today to observe organizations: transferring to

onshore providers those capabilities that were previously externalized to offshore

providers, and deciding to internally host capabilities that were previously

externalized.

Achieving External-Sourcing Agility at Commonwealth Bank of Australia30

The strategic advantages of demonstrating agility with regard to the external

sourcing of capabilities – that is, easily shifting capabilities from being internally

sourced to being externally sourced (or vice versa), and shifting the handling of a

capability from one provider to another provider – should be obvious. Organizations

demonstrating and maintaining agility significantly enhance the likelihoods of their

business models maintaining alignment with today’s dynamic competitive

environments. But, is agility with external sourcing feasible and cost-effective? The

experience of the Commonwealth Bank of Australia (CBA) indicates that it is both

feasible and cost-effective.

CBA is a large, multinational bank headquartered in Sydney, Australia. It has

built a strong reputation as a leading worldwide commercial user of digital

technologies (in regard to both spending and innovation). The banking sector is

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

30
This section has been adapted from: D. Schlagwein, A. Thorogood and L.P. Willcocks,
“How Commonwealth Bank of Australia Gained Benefits Using a Standards-Based, Multi-
Provider Cloud Model,” MIS Quarterly Executive, December 2014, pp. 209-222.
119
trust based largely in consumer perceptions regarding the security, reliability and

availability of digitalized banking services.

CBA has taken three different approaches to external sourcing over the past

twenty years:

 1996: CBA externally sourced much of its digitization and digitalization to

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

 2006: CBA transitioned to a multisourcing approach to the external sourcing

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

 2010: CBA initiated a multi-provider, cloud-based approach to the external

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

What exactly is CBA’s multi-provider, cloud-based approach to external sourcing? To

answer this question, a very brief introduction to cloud computing is needed.

Cloud computing involves provisioning a pool of digital assets and digitally-

enabled services such that these services can, on demand, be accessed and applied

by clients via the Internet. Cloud computing solutions provide individuals and

organizations with suites of capabilities in either private or public clouds, where these

clouds may be located close to or very distant from the client. The economics of

cloud computing are based on the sharing of a pool of resources across many uses

and many users, such that significant economies of scale and scope are realized.
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 CBA’s multi-provider, cloud-based model has three layers (see Figure 5-3).

The top layer consists of the business platforms that execute CBA’s operational and

managerial processes. The bottom layer includes internal (designed and operated by

CBA’s technology group), private external and public clouds – all of which comply

with CBA’s cloud standards. CBA collaborated with several cloud providers and other

strategic partners to develop and mandate these cloud standards. The middle layer,

which consists of a cloud management system, matches the digitalized applications

hosted in the top-layer business platforms to the bottom-layer digital platforms

(within which data processing and storage actually occurs). The primary purpose of

the cloud management system is to dynamically determine which provider’s cloud

should execute an application and to assign this application to that cloud. This cloud

management system is located inside CBA’s firewall, and CBA manages and controls

the system. Actual computing could take place on either side of the firewall according

to the cloud management system’s on-demand allocations.

Figure 5-3
CBA’s Multi-Provider, Cloud-Based External Sourcing Model

Business Platforms

Cloud Management System

External External External External

Internal
Private Public Public Public
Cloud
Cloud Cloud Cloud Cloud

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 The cloud management system executes operational and managerial

processes on-the-go, depending on current cloud workloads, the prices and service

level agreements negotiated with providers, and general requirements for security,

reliability and availability. In addition, the structure shown in Figure 5-3 makes it

relatively easy, as long as architectural standards are met, to enhance business

platforms, to replace business platforms or to add new business platforms. Finally,

this structure is not limited by the number of connected cloud-providers, and it allows

for the rapid connection of newly-contracted providers and the rapid disconnection of

terminated providers.

A Recap and Look Ahead

Organizations implementing competitively-successful business models must be

able to quickly and competently apply numerous digitized and digitalized capabilities,

many of which are quite sophisticated and some of which have only recently emerged.

It would be simply impossible for any organization to accomplish this on their own

today. This chapter has explained why and how organizations externally source

many, if not most, of the capabilities being applied, and then described how the

external sourcing of capabilities is factored into organizations’ processes for digital

strategy formulation.

While the external sourcing of capabilities is important for both pipeline

organizations and network organizations, it is especially critical for network

organizations given these organizations’ intense reliance on digital platforms and

business platforms in the launch and evolution of their business models. The next

chapter describes the nature of business models within network ecosystems.

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 Chapter 6. Digitalized Business Models for Network Ecosystems

Today, when you use your smartphone or tablet to post content on Facebook

statuses, to tweet, exchange photos, or search for information on the Internet, you

expect these types of Internet-based services to be provided mostly free-of-charge.

In economic terms, this amounts to a vast consumer surplus being provided by

organizations offering such services. Why do organizations (e.g., Facebook, Twitter,

WhatsApp, Google, etc.) offer these free services? The not-so-subtle answer is quite

straightforward – to generate revenue streams (via advertising or access fees) by

enabling other organizations to touch an expanding network of consumers or to gain

access to information about these consumers.

But, how does this occur? Most often, it occurs through the creation of a

network (market-focused) ecosystem, with the core transaction of the market being

the free service: a Facebook post, a Twitter tweet, a WhatsApp photo-share, or a

Google Internet search. The core transaction of a network ecosystem is the

primary market exchange activity driving both producers and consumers to an

ecosystem’s market platform. The market platform of a network ecosystem is the

organized collection of digital and business platforms that hosts the content and

functionalities that establish, operate and govern the ecosystem’s market. In order

to better grasp the nature of a network ecosystem, let’s take a closer look at Google

and Facebook. Also, for the ease of understanding, we will refer to the networks

being brought together within a network ecosystem as communities.

The core transaction enabled by Google is a consumer’s search for specific

content (some unit of information) believed to exist on one or more producer websites

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(see Figure 6-1). Note especially the third community involved with Google’s

ecosystem: advertisers. Having developed state-of-the-art search algorithms and an

innovative auction scheme for selling advertising associated with specified search

outcomes, Google has built a business model that profitably monetizes Internet

search by attracting large customer and advertiser communities. Interestingly,

considerable overlap does exist across the three communities interacting through

Google’s search platform: website producers and advertisers do Internet searches

(that is, act as consumers), website producers do advertise, and advertisers do place

content on websites.

Figure 6-1
Google’s Network Ecosystem

• Relevant, useful
Consumers
information
Seeking
• Ease of use
Information
• Access from anywhere

Advertisers Producers
of Websites
Google’s
Market
Platform

• Access to network of • Increased traffic

potential buyers • Revenue opportunities
• Measurable ROI on ads • Access to network of
• Precise campaign control: advertisers
pay for clicks

The core transaction enabled by Facebook is a person’s posting of content

(accompanied by Facebook immediately notifying the consumer’s friends of the

posting). As depicted in Figure 6-2, the person posting content is a member of a

producer community and the friends wishing to see the posted content are members

124
of a consumer community. Somewhat unique to social media sites, these consumer

and producer communities essentially overlap their memberships (aside from pure

lurkers within the consumer community). Note also that Facebook’s ecosystem

involves two additional communities: advertisers and Facebook App producers.

Facebook generates revenue streams from these advertisers and App producers.

Figure 6-2
Facebook’s Network Ecosystem

• Access to networks Producers

of consumers & Consumers
of Facebook Seeking • Relevant, useful
producers Apps content
• Revenue Content
• Ease of use
opportunities • Access from
• Access to network anywhere
of advertisers

Facebook’s Producers
Advertisers Market of Content
Platform

• Global audience of
• Increased traffic
potential buyers
• Revenue opportunities
• Measurable ROI on ads
• Access to network of
• Precise campaign control:
advertisers
pay for clicks

This chapter introduces intuitive ways of thinking about network ecosystems

and about the digital and business platforms used to orchestrate the market spaces

established by network ecosystems. The following topics are covered:

 Why Network Ecosystems Exist

 Crowd-Based Capitalism

 Digitalizing Network Ecosystems

 Blended Organizations

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Why Network Ecosystems Exist

In explaining the economic concepts that underlie network ecosystems, we use

the example of a simplified hypothetical social media ecosystem (see Figure 6-3).

Here, community members take on the roles of producers and consumers in order to

share content. By sharing content – and, hence, gaining exposure to each other’s

likes, dislikes, experiences and perspectives - members enrich their relationships

with each other. What is the value proposition that drives a person to join,

participate, and remain in a social media ecosystem? It is the promise of more-

intensively sharing content with individuals with whom a personal relationship

already exists or of sharing content with individuals with whom no (or, at best, a

casual) personal relationship currently exists, but with whom a richer personal

relationship is desired.

Figure 6-3
Simplified Social Media Ecosystem

Social Media
Community
Producers Consumers
of Content Seeking
Content

Social
Media
Platform

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 This social media ecosystem value proposition is driven by what economists

refer to as network effects. Stated simply, as the social community grows linearly,

the number of possible relationships amongst the community’s members grows

exponentially: 1 member - 0 possible relationships, 2 members – 1 relationship, 4

members – 6 possible relationships, 12 members – 66 possible relationships, 100

members – 4,950 possible relationships, and so on. Bigger networks, as a general

rule, are more valuable to participants; thus, network effects give network

ecosystems with the largest participant communities an advantage that is hard for

competitors to overcome. We explore network effects further, starting with two-

sided markets, moving on to multi-sided markets, and concluding with a discussion

of winner-take-all markets - the competitive endgame of a market-focused network

ecosystem.

Network Effects

Network effects, or what economists term a network externality, refer to

situations where the worth of or demand for a value-unit grows as an exponential

function of the number of current consumers of a value-unit and/or the number of

complements available to these consumers. A complement increases the perceived

worth of a value-unit. A good example of a complement would be the apps available

for a particular social media ecosystem, e.g., apps that make it easier to manipulate

and share content across the ecosystem. Would you be more inclined to join a social

media ecosystem that had more or fewer of your current friends as participants?

And, is this more likely for larger or smaller social media ecosystems? Now, given

two social media ecosystems comparable regarding the likelihood of you being able

to share content with your friends, would you prefer the ecosystem with more or

127
fewer valued complements (e.g., an image manipulation app)? And, would app

producers be more inclined to create apps for larger or smaller social media

ecosystems? This is the power of network effects!

How can firms capture the opportunities available through positive network

effects? Positive network externalities occur only when a customer network is

satisfied with – better yet, enthused about – the value-unit being offered. Much of

Apple’s surge in product success (iPod, iPhone, iPad, iTunes, iMusic, etc.) is a direct

result of positive word-of-mouth chatter. In contrast, negative customer experiences

and perceptions can be devastating.

The competition between HD DVD and Blu-ray as the standard for DVD players

provides an example of network externalities in action. Consider this quote from

Matthew Smith, a former SVP of merchandising for Blockbuster:31 “The consumers

are sending us a message. I can’t ignore what I’m seeing. Blockbuster has been

renting both Blu-ray and HD DVD titles in 250 stores since late last year and found

that consumers were choosing Blu-ray titles more than 70 percent of the time.”

Relatively quickly, word-of-mouth and consumer purchase decisions led to a positive

network effect for Blu-ray titles, subsequent growth in the number of Blu-ray titles

offered for sale or rent relative to the number of HD titles, and Blu-ray ultimately

winning the DVD standards war.

Because of the power of network effects, it is critical for network ecosystems

to exploit the influence of word-of-mouth and enlist their communities in growing

both community membership and member participation within a community.

31
R. Harris, “Blu-ray vs. HD DVD: Game Over,”
http://blogs.zdnet.com/storage/?p=149.
128
Another tactic for capturing network effects with network ecosystems is to carefully

define the architectural standards enabling connectivity and interoperability and

promote these standards such that the standards become dominant in the network

ecosystem market space. Winning standards wars is critical as this increases the

number and variety of complements available to participants. A primary factor

behind Microsoft’s dominance in PC operating systems was the wide variety of

software applications compatible with the Windows operating system. This reinforces

the dominance of Windows in the market for PC operating systems. Firms become

successful in standards wars either by leveraging their brand and existing market

presence (e.g., a Microsoft, an IBM, an Apple, a Google, etc.) or by forming alliances

with other firms and collectively engaging in persuasive tactics to influence an

industry-wide movement toward a favored standard (e.g., Bluetooth, GSM for

mobility services, Android for smart phones, etc.).

Two-Sided Markets

A key notion for understanding the nature of network ecosystems involves the

economics of two-sided markets.32 With a two-sided market, the ecosystem

owner/builder – the network orchestrator – brings together two distinct communities

to engage in value-unit exchanges. Most typically, this is accomplished by growing

one side of the market as a means of attracting participants to the other side of the

market. The two sides of the network ecosystem are perhaps best thought of as a

subsidy-side and a money-side, with the ecosystem’s market platform providing

32
T. Eisenmann, G. Parker and M. Van Alstyne, “Strategies for Two-Sided Markets,”
Harvard Business Review, October 2006, pp. 92-101.
129
the rules, functionalities and resources to attract participants and to facilitate value-

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

participate in a network ecosystem as the primary role of the subsidy-side is to attract

the money-side, from which revenues are generated. The basic idea, thus, is to grow

the subsidized community to the point that its size becomes sufficient to attractive

money-side participants willing to pay a fee to gain access to the subsidy-side

participants.

As an example of a two-sided market, consider Figure 6-4, which depicts a

generic job-recruiting network ecosystem, e.g., CareerBuilder, Monster, Job.com,

etc. The subsidy-side is the community of individuals looking for a job. By heavily

subsidizing (free?) participation and by offering useful rules (e.g., privacy),

functionalities (e.g., resume-builder) and resources (e.g., career advice content), a

large pool of job candidates is built. If this pool of job applicants is large and of high

quality (e.g., broad ranges of skills and experiences), a high likelihood exists that a

sizable pool of recruiters will be attracted despite the participation fees being charged

to these recruiters (typically, a recruiter might be charged a modest fee to post a job

opportunity, a slightly larger fee for each match that occurs, and a much larger fee

if and when an applicant is offered a position).

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 Figure 6-4
Generic Job Recruiting Network Ecosystem

Recruiters Applicants

(Producers of Jobs) (Consumers of Jobs)

Market Platform

Rules Functionalities Resources

Another, quite different, example of a two-sided market involves Adobe and

its Adobe Reader and Adobe Acrobat software (see Figure 6-5). Before Adobe Reader

and Acrobat were released, the established standard for sharing and printing

documents was a tool called PostScript. In order to make inroads into the lucrative

document creation software market, Adobe made its document reader software freely

available (subsidizing the consumers of digital documents) and encouraged adopters

to share information about Adobe Reader and how to obtain it. With positive word-

of-mouth by a large number of Adobe Reader adopters, Adobe Reader became the

de facto standard for document reading and sharing. Once Adobe Reader became

the dominant document reader for viewing any type of document, Adobe was able to

sell its document-creation software, Acrobat, to all types of document creators:

publishers, law firms, authors, etc. While Adobe continues to give Adobe Reader

131
away for free, it generates sizeable revenues through its Acrobat software (now

available only by lease, a more-profitable pricing tactic).

Figure 6-5
Adobe’s Two-Sided Market Business Strategy

Producers of Consumers of
Digital Documents Digital Documents

Market Platform

User Authentication &

Software Products
to Download Account Management

Payment Systems Customer Support

& User Manuals

What is important about Adobe’s strategy? Adobe could have enjoyed the

benefits of network effects by only offering Adobe Reader - by standardizing their use

around it, consumers of digital documents would be able to easily exchange

documents and read them on any type of device. However, would this positive

network effect benefit Adobe to the same extent it benefited Adobe’s customers? In

other words, would Adobe have been able to eventually sell Adobe Reader at a price

sufficient to generate a lucrative profit? What price could it charge without hurting

its ability to build a critical mass of document reader users? Adobe recognized that

rather severe limits existed regarding what people would be willing to pay for a

document reader. But, Adobe also recognized that it could generate substantial

132
revenue from document-creation software given that it could achieve a large,

installed base of Adobe Reader users.

Figure 6-6 provides a more nuanced depiction of the logic underlying a two-

sided market. Note that two types of positive network effects are in play. The first

is called the same-side effect and refers to the possibility of network effects with

each side of the market. In the case of Adobe, as more people adopt Adobe Reader

for viewing documents, each is presented with more opportunities to easily share

documents. This represents a positive, same-side network effect for the adopters of

Acrobat Reader. Potential same-side network effects exist, as well, for document

producers. As more producers adopt Adobe Acrobat for document creation, more

opportunities arise for these producers to exchange content in order to create

bundled offerings.

Figure 6-6
Same-Side and Cross-Side Network Effects

Side #2
Side #1

Same-side effect

Market
Platform Cross-side effect

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 The second type of positive network effect is called a cross-side effect. This

refers to the potential value that one side derives when there are more participants

on the other side. Again, using the Adobe example, adopters of Adobe Reader benefit

as more producers adopt the Adobe Acrobat document creation software (because of

the increase in the number of compatible digital documents), and document

producers benefit with an increase in the number of consumers reading digital

documents through the use of Acrobat Reader (a larger consumer market for

produced digital documents).

So far, our discussion has been based on the assumption that same-side and

cross-side network effects are always positive. This is not the case, as these network

effects could be negative. Refer back to the job recruiting network ecosystem

portrayed earlier as Figure 6-4. Are the same-side network effects positive or

negative? Does a growing pool of job applicants benefit each applicant participating

in the ecosystem? Does a growing list of recruiters benefit each recruiter participating

in the ecosystem? Possibly not, as this may translate into greater competition among

applicants for the best jobs, as well as greater competition among recruiters for the

best candidates. Even though each side benefits from positive, cross-side network

effects, the potential for negative, same-side network effects could limit the number

of job seekers or job providers willing to participate in the ecosystem.33

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

Increasingly, today’s network ecosystems are designed as multi-sided markets

rather than as two-sided markets. A multi-sided market involves more than two

actively participating communities. In this chapter’s introduction, we described a

three-sided market (the Google search network ecosystem) and a four-sided market

(the Facebook social media network ecosystem).

With multi-sided markets, each added community presents an opportunity to

generate additional revenue streams. Facebook, for example, receives revenue from

advertisers and from app producers. But, this potential for increased revenue is

accompanied by three management challenges:

 Creating and then evolving attractive value propositions for each

participating community.

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

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

As the number of communities participating in a multi-side network increases, the

complexity of these management challenges tends to increase in a nonlinear fashion.

Winner-Take-All Markets

Increasingly, the payoff gap between being the best competitor in a market

and the second-best is widening into a canyon. This applies to labor markets (e.g.,

professional athletes), to technology markets (e.g., technology producers), and

especially to network ecosystems. In explaining the nature of winner-take-all

markets, we begin with the most straightforward context – that of a digital

product/service.

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 As positive network effects drive more consumers to adopt a product or

service, the product/service can gain a critical mass of adopters and become

dominant in its market space. This same phenomenon occurs with network

ecosystems. A critical mass of network ecosystem participants is achieved when the

momentum produced by an ecosystem’s positive network effects is unlikely to be

reversed by the entry into the market space of an appealing new network ecosystem,

regardless of how appealing this new ecosystem’s value-units might be. Think of the

market dominance held by Microsoft Windows and Office, by Google’s Android and

Gmail, and by Blu-ray DVD players and movies. In each of these cases, the

respective markets are said to have tipped over with the winner crowding out rival

products or services. A winner-take-all market, thus, refers to a market where

the potential exists that a critical mass of consumers will adopt one producer’s

products/services.

Nintendo’s entry into the home video gaming market nicely demonstrates how

competition unfolds in winner-take-all markets. In 1985, Atari was the dominant

firm in the video game market. By Christmas 1986, the Nintendo Entertainment

System (NES) had emerged as a very popular product, creating positive network

effects with both customers and, importantly, game developers, in turn attracting

even more customers. At some point, the market tipped over to Nintendo as the

dominant competitor. Once this occurred, game developers were willing to produce

their software exclusively for Nintendo for a two-year period – indicating the

significant rewards winners can obtain in winner-take-all markets. Microsoft’s

business strategies with its operating systems and its Office software suite reflect

similar competitive dynamics.

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 Network ecosystems are particularly susceptible to winner-take-all markets.

Three factors tend to characterize winner-take-all network ecosystems:

 Strong producer economies of scale.

 Strong positive cross-side network effects.

 High consumer switching costs.

The latter factor is especially important. When participating in a competitor network

ecosystem is perceived as being costly (i.e., a non-trivial investment is required to

participate in a network ecosystem and this investment is then lost in moving to a

different ecosystem), consumers will be reluctant to either participate in multiple

network ecosystems or to switch ecosystems.

Importantly, not all market spaces are susceptible to winner-take-all market

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

LivingSocial.34 Many early investors believed that strong cross-side network effects

would produce high stock valuations for Groupon and for LivingSocial. However, as

consumers participating in Groupon and in LivingSocial experienced very low

switching costs, little allegiance was shown to any one market platform with

consumers instead skipping through multiple platforms looking for the most attractive

deals. As one might expect, the high valuations have yet to materialize.

Generally, a market space susceptible to winner-take-all dynamics is most

likely to be seen as a winner-take-all network ecosystem when:

 Participants experience significant, positive network effects.

34
A. Haigu, “Strategic Decisions for Multi-Sided Platforms,” Sloan Management
Review, Winter 2014, pp. 71-80.
137
  Participants are reluctant to move to a competing ecosystem.

 One of the network ecosystems begins to attract a majority of the new

participants entering the market space.

 This same ecosystem attracts an accelerating flow of participants from

competing ecosystems.

Competition in early-stage winner-take-all network ecosystem market spaces can be

fierce. More profitable competitors, because they are more profitable, are able to

invest more in R&D and to provide greater incentives to participants - enabling their

participating communities to grow even faster. This intense competition often results

in winner-take-all market spaces being dominated by just a few firms (two or three,

at most).

Crowd-Based Capitalism

The past decade has witnessed a reemergence of bartering, the earliest type

of market-focused ecosystem, in the form of crowd-based capitalism – that is, a

two-sided market that brings together two crowds, or communities, of individuals:

one community possessing an under-used asset or skill (the value-unit) and the other

possessing a short-term need for such an asset or skill. This new bartering ecosystem

differs from the original in two important ways:

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

 The market is enabled through a digitalized market platform built, managed

and owned by a third-party, the network orchestrator.

138
This form of market-focused ecosystem is the basis for what is popularly referred to

as to as the sharing economy.35 Essentially, digital technologies (e.g., the Internet,

interconnected smart devices, social media, payment systems, trust systems, etc.)

are extending peoples’ options for obtaining goods and services beyond family,

friends, neighborhood stores and national/global retailers toward crowds of

entrepreneurs.

Table 6-1 lists some of the crowd-based network ecosystems that have

emerged over the last decade. As you look over this listing, notice the attributes of

value-units likely to be shared via crowd-based capitalism: low-use and high-value.

Low-use implies unused capacity (of an asset) or idle time (of a skill-provider); high-

value infers that the value-created – the consumer payment subsequently

appropriated and shared by a producer (an asset-owner or skill-provider) and a

network orchestrator – will exceed the costs associated with an exchange.

35
A. Sundararajan, The Sharing Economy: The End of Employment and the Rise of
Crowd-Based Capitalism, MIT Press, Cambridge, MA, 2016.
139
 Table 6-1
Examples of Crowd-Based Network Ecosystems

Crowd-Based
Value-Unit Examples
Network Ecosystem
Educational Services Idle Skill Capacity SkillShare,TradeSchool, Udemy
Amazon Mechanical Turk,
Freelance Work Idle Expertise Capacity
InnoCentive, TopCoder, Upwork
AngelList, FundiingCircle,
Fundraising Idle Capital
Kickstarter
Handyman Chores Idle Labor Capacity Handy, TaskRabbit, TimesFree
Designer24, Rendevoux, Rent My
High-End Fashion Unused Clothes Wardrobe, Rent the Runway,
StyleLand
Lodging Unused Housing Capacity Airbnb, CouchSurfing
Lux, Postmate, Shyp, Washio,
Personal Services Idle Labor Capacity
Wag
Philanthropy Idle Capital DonorsChoose, Kiva
Unused Automobile BlaBlaCar, Getaround, Lyft, Turo,
Transportation
Capacity Uber, Zipcar

Digitalizing Network Ecosystems

Network ecosystems existed prior to the eras of digital disruption. For

example, three pervasive pre-digital network ecosystems were those involving (as

network orchestrators) real estate brokerages, independent insurance agencies and

travel agencies. In these network ecosystems, the network orchestrator (via the

work processes shown in Figure 6-7):

 Built up a portfolio of offerings from a producer community.

 Attracted a consumer community.

 Enriched producers’ offering creation capabilities.

 Enriched consumer demand.

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

 Facilitated both exchange transactions and exchange fulfillment.

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

With digitalized network ecosystems, the vast majority of work processes are carried

out through a market platform (i.e., a collection of digital platforms and business

140
platforms). The digitization and digitalization reflective of the three eras of digital

disruption (see Table 6-2) have produced two types of effects on network

ecosystems. First, the pre-digital network ecosystems have either radically

transformed themselves through both digitalization and specialization or have exited

their markets. Second, scores of new network ecosystems have emerged and

continue to emerge (see Table 6-3).

Figure 6-7
A Network Orchestrator’s Managerial and Operational Processes

Business/Digital Strategizing; Administrative Services

Financial Services; Accounting Services

Digital Technology Services & Management

Processes
Support

Human Resource Recruitment & Development; Benefits Management

R&D; New Services Development; New Services Rollout

Indirect Materials & Supplies Procurement

Growing a Facilitating
Producer Producer Retaining
Matching Transaction
Value-Unit Exchange Producer
Processes

Community Consumer
Primary

Creation Execution Fulfillment Community

Demand Efficiency
Growing a With Execution
Stimulating & Safety & Safety Retaining
Consumer Producer
Community Consumer Consumer
Supply
Demand Community

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 Table 6-2
Evolution of Network Ecosystems

Exchange Trust
Era Value-Units Digitization & Digitalization
Currency Systems
 Data/document standards  Government &
 Point-to-point connectivity  Banking 3rd- party
Digital  Intra- and inter- system institutions
1
complements organizational (managerial  Credit/debit  Contracts
and operational) process card systems  Brand
efficiencies  Social capital
 Internet
 3rd-party digital
 One-to-many connectivity
trust seals
 Data, process, analytic and  Digitalized
Digital value-  Consumer
2 collaboration platforms payment
units monitoring
 Social media systems
(product &
 Omni-channel producer-
producer reviews)
consumer interaction
 Many-to-many connectivity
 Community
 Smart devices  Reputation
Social monitoring
3  Big Data platforms  Social capital
complements  Peer-regulation
 Big Data analytic platforms  Bitcoins
 Self-regulation
 Social messaging platforms

Table 6-3
Examples of Network Ecosystems

Era Variation Examples Community 1 Community 2 Community 3

Producing
Services Platform Visa, MasterCard Banks Consumers
Organizations
1
Microsoft’s PC Application
Digital Architecture PC Producers Consumers
Operating System Producers
B2B Horizontal Alibaba.com, Producing Consuming
Advertisers
Marketplace Thomasnet.com Organizations Organizations
B2B Vertical e-Steel, Producing Consuming
Advertisers
2 Marketplace Farms.com Organizations Organizations
Amazon Producing
B2C e-Commerce Advertisers Consumers
Marketplace Organizations
C2C e-Commerce eBay, Craigslist Producers Advertisers Consumers
Content Content
Search Platform Google Advertisers
Producers Consumers
Social Media Content Content
3 Twitter Advertisers
Platform Producers Consumers
Crowd-Based Asset/Skill Asset/Skill
Airbnb, Uber Advertisers
Capitalism Owner User

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Era 1

Two types of network ecosystems emerged during Era 1. The first of these

applied proprietary, point-to-point connectivity to create new markets based on

digitalized services. Perhaps the most familiar example is that of credit card

providers, such as Visa and MasterCard. By establishing a digitalized (in part)

services platform, merchants were able to offer a convenient, safe payment channel

to consumers and banks gained a new revenue stream.

The second type of network ecosystem that emerged involved proprietary

architectures for digital products and these product’s complements. By promoting

and licensing a product architecture that tips over a market, the architecture’s creator

is able to sustain high-margin sales for a lengthy period of time. Perhaps the most

familiar example of this is that of personal computer (PC) operating systems, such

as Microsoft OS (and then Windows). The Intel PC operating system market tipped

over to Microsoft OS because the PC application software community gave priority to

developing products to run on OS (and then on Windows) – increasing the likelihoods

that software producers would gain large revenue streams and that consumers

purchasing PCs would be able to run needed software.

Era 2

The availability of one-to-many connectivity enabled by the Internet triggered

a rapid growth in network ecosystems. Four distinct types of e-commerce

ecosystems emerged: B2B horizontal (producers offering a broad range of value-

units to any type of consumer-business) marketplaces, B2B vertical (producers

offering value-units to consumer-businesses in a single industry) marketplaces, B2C

marketplaces, and C2C marketplaces.

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 B2B marketplaces generally operate in the upstream portions of industry value

streams. Connecting (raw material and component) suppliers to producers, these

intermediaries aim to disintermediate established supplier-producer relationships

with the promise of a more efficient market. The value-propositions of these B2B

marketplaces vary considerably, as reflected in the four levels of functionality that

can be established between producers and consumers: information exchange, value-

unit exchange/fulfillment transaction execution, logistical flow coordination, and

collaboration enablement.

B2C and C2C marketplaces generally operate in the downstream portions of

industry value chains. Connecting finished goods producers to consumers, these

intermediaries aim to disintermediate established retailer-consumer relationships,

again with the promise of a more efficient market. Notice in Table 6-3 (shown earlier)

that the example given for an Era 2 B2C network ecosystem is Amazon Marketplace

rather than Amazon, given Amazon Marketplace’s objective of bringing together a

broad community of small producers to interact with Amazon’s consumer community.

Two examples of C2C marketplaces, eBay and Craigslist, are used to illustrate the

variety that exists. For example, eBay utilizes an auction pricing mechanism and

offers the parties of value-unit exchanges a range of transactional and fulfillment

services, while Craigslist utilizes fixed prices and offers little in the way of

transactional and fulfillment services.

Era 3

The digital technologies associated with the third era of digital disruption –

most notably many-to-many connectivity, smart devices, social messaging and peer

regulation – triggered a fresh, explosive wave of network ecosystems focused on

144
enabling and exploiting individuals’ desires to maintain anytime, anywhere

connections with the people, institutions and opportunities that are most important

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

ecosystems involve digital services (e.g., search, photo sharing, music sharing, etc.),

social media, and crowd-based capitalism. As many of these network ecosystems

involve participants and activities outside of the purview of established markets and

institutions, new forms of community-based and peer-based trust systems have

emerged. For example, there are limited regulations at present to assure consumers

of the accuracy of host-provided Airbnb lodging descriptions. In response, Airbnb

has implemented two trust mechanisms: the capturing and reporting of consumers’

lodging reviews, and host identity verification systems that combine the digitized

social capital of social media with governmental ID infrastructures. In addition,

Airbnb proactively involves hosts and consumers in developing and evolving

standards and expectations guidelines that must be agreed-to by hosts and

consumers.

Blended Organizations

Today’s most successful organizations are increasingly exhibiting the qualities

of both pipeline ecosystems and network ecosystems, and in the process becoming

a blended organization. This primarily occurs via one of two approaches:

 An organization operates multiple, largely independent business models,

some of which are executed as a pipeline organization and others as a
network organization.

 A pipeline organization incorporates a private or semi-private network-

ecosystem as a means of enhancing efficiency, effectiveness or both.

Each of these approaches is briefly described.

145
 The organization that best illustrates the first approach of operating both

pipeline ecosystem and network ecosystem business models is Amazon. Amazon’s

initial business model was that of a pipeline ecosystem retailer: interacting physically

with suppliers to stock product inventories, then interacting digitally with customers

to sell these products, and then interacting physically and digitally with third-party

package delivery providers in fulfilling customers’ purchases from Amazon’s brick-

and-mortar distribution centers. Over time, Amazon has expanded its portfolio of

business models to include operating as:

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

 A pipeline ecosystem producer of digital technology services for businesses

and for individuals.

 A network ecosystem orchestrator of media streaming services.

 A network ecosystem orchestrator of B2B and B2C marketplaces.

While Amazon’s various business models are targeted at distinct markets, they all

make extensive use of Amazon’s world-class capabilities to design, build, operate and

evolve digital platforms and business platforms.

The second approach to becoming a blended organization involves a focus on

upstream, internal and/or downstream processes.

With regard to upstream processes, for many producers (e.g., automobiles,

durable appliances, electronic products, etc.) a few of the raw materials used in

procured components represent a significant percentage of production costs. Part A

of Figure 6-8 portrays a traditional upstream value stream for a pipeline

manufacturing organization. Note that value stream participants engage with two

largely-independent markets: Market 1 involves raw material suppliers and

146
component suppliers, and Market 2 involves these component suppliers and the

producers. Because of the potential for supply/demand imbalances and information

asymmetries, component suppliers tend to be disadvantaged in Market 1, passing on

market inefficiencies to the manufacturer in the form of higher prices and logistical

delays in Market 2. Part B of Figure 6-8 introduces the notion of a supply hub as a

means of overcoming these potential market inefficiencies in this upstream portion

of the traditional pipeline value stream.36 Here, the manufacturer creates a pseudo-

market (Market 3) within the established market for raw materials. After aggregating

raw material requirements and production plans across all component suppliers, a

producer is able to apply a comprehensive understanding of component supplier

demand (volumes and timings) in negotiating prices with raw material suppliers on

behalf of the component suppliers.

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

147
 Figure 6-8
Introducing a Supply Hub into a Pipeline Ecosystem Value Stream

A. Traditional Value Stream B. Raw Material Supply Hub

Raw Raw
Material Component Material Component
Producer Suppliers Producer
Suppliers Suppliers Suppliers

1 2
Markets
Markets

With regard to internal processes, organizations can obtain a variety of benefits

(e.g., productivity, employee goodwill, reputation enhancement, etc.) by employing

a private network ecosystem solely inside their boundaries. The platforms used with

such internal marketplaces can be developed in-house or licensed from a third-party

platform-provider. A nice example of using a private market ecosystem is that of

Zimride, the ride-sharing platform that Lyft’s founders licensed to universities and

businesses as a private ride-sharing service used solely by a subscribing

university’s/business’s employees.37 Zimride provides a useful benefit for employees

in the form of a convenient and safe mechanism for solving employees’ commuting-

to-work problems and positions the organization as being socially-responsible, a

quality likely valued by many of the organization’s stakeholders.

R. Lawler, “Lyft-Off: Zimride’s Long Ride to Overnight Success,” TechCrunch, August

37

29, 2014: https://techcrunch.com/2014/08/29/6000-words-about-a-pink-mustache/

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 With regard to downstream processes, Table 6-4 provides examples of three

organizations that have appended C2C marketplaces as complements to their

traditional sales channels. When carefully conceived and executed, the network

effects engendered can be exploited to enrich a brand and grow the consumer base

without cannibalizing pre-existing sales channels.

Table 6-4
Introducing a C2C Marketplace into a Pipeline Ecosystem Value Stream

Pipeline
Network Ecosystem
Organization
Ikea Family loyalty program
Ikea Group community: members post &
sell used Ikea items.
Partnership with eBay:
Patagonia consumers easily sell used
Patagonia clothing items.
DM Sponsors & arranges clothing
(German swap events, at which
Drugstore makeup/styling products &
Chain) techniques are demonstrated.
Strategic Value
 Supports Ikea’s eco-friendly
ethos.
 Opens up room in members’
homes for new Ikea items.
 Supports Patagonia’s eco-friendly
ethos.
 Increases the visibility of the
Patagonia brand both online and
on the street.
 Generates new consumers in the
targeted demographic.
 Enriches brand by leveraging the
green spirit of sharing rather than
buying.
 Gains brand visibility as these
events are featured on social
media and by fashion bloggers.

A Recap and Look Ahead

Network ecosystems, as introduced and fleshed out in this chapter, represent

a rapidly increasing segment of most countries’ GNPs. In the process, existing

markets and industries are being transformed and new markets and industries are

being formed. The next chapter examines the digital strategy formulation process

for network orchestrators, regardless if a network orchestrator offers a market

platform for a public or private network ecosystem.

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 Chapter 7. Digital Strategy Formulation for Network Organizations

Within a network ecosystem, market participants connect and conduct

interactions with one another using a market platform provided by a network

organization – the network orchestrator. While interacting, market participants make

use of platform content/functionality to exchange data, exchange items of value

(e.g., value-units, monetary payments, etc.), and collaborate in co-creating new

value-units.

This chapter discusses digital strategy formulation within network

organizations. Because of the huge variety of network ecosystems, our discussion

will be in the form of general concepts and frameworks – that are then grounded

through two different network organizations (see Figure 7-1 and Table 7-1):

TopCoder38,39 and Metropia40. TopCoder is an established organization that has

constituted a single network ecosystem handling all of TopCoder’s work activities;

Metropia is a relatively young organization that aims to constitute many local

(geographically-bound) network ecosystems.

38
H. Tajedin and D. Nevo, “Value-Adding Intermediaries in Software Crowdsourcing,”
47th Hawaii International Conference on System Sciences, IEEE, January 2014, pp. 1396-
1405.
39
H. Tajedin, D. Nevo and R.W. Zmud, “Beyond Matching: Intermediaries’ Market
Design and Market Development Roles in Software Development Crowd Markets,” working
paper, Rensselaer Polytechnic Institute, January 2017.
40
The Metropia material has been gathered by one of this book’s authors through
interviews with two members of Metropia’s leadership team, including the founder/CEO.
150
 Figure 7-1
The Communities Participating in TopCoder and Metropia

TopCoder Metropia

Mobility
Commuters Service
Clients Developers Providers

Merchants Government
Agency

Market Market
Platform Platform

Table 7-1
Describing and Contrasting TopCoder and Metropia

TopCoder Metropia
Delivering a solution (software Provide an optimal mobility
code) that satisfactorily meets solution for moving the
Core Transaction
a client’s specification (a commuter from point A to
software project) point B
Clients Commuters
Community 1
(money-side) (money-side)
Developers Mobility Providers
Community 2
(subsidy-side) (subsidy-side)
Merchants
Community 3
(subsidy-side)
Government Agencies
Community 4
(money-side)
Market Geographic
Global Local
Scope
Maturity Established Young

Founded in 2001, TopCoder offers crowdsourced software design and

development services to (mostly North American Fortune 500) clients across

numerous industries. As of May 2015, TopCoder had built a community of over

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700,000 developers, of which nearly 20% were active. Metropia was founded in 2010

as a Mobility-as-a-Service (MaaS) platform for commuters in congested urban areas.

At the time this case material was collected, Metropia was in five urban areas (Austin,

El Paso, Houston, New York City and Tucson) and was in various stages of rolling out

platforms in five additional urban areas.

The chapter introduces intuitive ways of thinking about the digital strategies

formulated by network organizations as they establish and evolve network

ecosystems by covering the following topics:

 Business Models for Network Organizations

 Strategic Intent for Network Organizations

 Market Design and Market Platform Design

 Digital Strategy Formulation

 Sustaining a Network Organization’s Market Position

Business Models for Network Organizations

Business models for network organizations (see Figure 7-2) differ from those

of pipeline organizations in two primary ways:

 The presence of an additional business model element – the number of

communities interacting through a network organization’s market platform.

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

Typically, two of these interacting communities are directly associated with the core

transaction: the producer and the consumer of the value-unit(s) being exchanged via

the constituted market. Other interacting communities are then attracted by the

opportunity to touch producer participants, consumer participants, or both. A

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

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of engaging value propositions for each of the interacting communities, and (2) a set

of community profit models that additively produce a profitable revenue stream.

Figure 7-2
Business Models for Network Organizations

Community Community
Value Profit Models
Propositions

Number of
Communities

Core Dynamic
Capabilities Capabilities

Similar to pipeline organization business models, network organizations deliver

value propositions and profit models through sets of core capabilities and dynamic

capabilities. As might be expected, these capabilities tend to vary somewhat with

regard to the community (or communities) being targeted. Consequently, capability

development and management requires the balancing (for effectiveness and

efficiency purposes) of local (a single community) and global (all communities)

interests.

Table 7-2 provides an overview of TopCoder’s business model. Here,

tournament-style crowdsourcing is applied to incentivize a developer community (the

producer) to deliver software solutions (the value-unit) to a client community (the

consumers). Importantly, the client community is the money-side of the market,

while the developer community is the subsidy-side. Client software projects are

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

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specification, version design, version coding/testing, etc.), with three (or so) winning

solutions selected for each contest. The client accepts one of these winning solutions

as the overall winner and the project-related work then moves on to the next contest.

The core transaction is contest design and fulfillment – the delivery of a satisfactory

contest solution to a client.

Table 7-2
TopCoder’s Business Model

Business Model
Description
Element
Client Community Obtain quality code (e.g., tested against specifications, secure,
Value Proposition etc.) within agreed-on schedule and budget.
 Clients pay subscription fee.
Client Community
 Clients provide contest incentives (payments to winning
Profit Model
developers).
Developer Community Earn income, acquire new skills, demonstrate skills and interact
Value Proposition with forward-looking technologists.
Developer Community No associated revenue stream (the developer community is the
Profit Model subsidy-side of this network ecosystem).
 Software development & software development management.
 Translating software development projects into contests.
Core Capabilities  Contest design & fulfillment.
 Acquiring, developing and retaining community participants.
 Creating a sense of community for participants.
 Sensing & identifying software development trends &
Dynamic Capabilities innovations.
 Sensing & identifying new participant sources.

Metropia’s business model (summarized in Table 7-3) is more complex. The

core transaction involves a commuter desiring to move from point A to point B by

selecting one of a number of offered mobility solutions: self-navigation (driving,

walking, bicycling), toll roads, car-pooling, ride-sharing, car-sharing, bike-sharing,

ride-hailing, various mass transportation modes, etc. The mobility service portfolios

vary across the local market platforms, and the offered solutions are produced

through the application of sophisticated traffic algorithms on massive collections of

historical and streaming traffic-related data. The commuter earns reward points for

selecting solutions that contribute to the common good, and these reward points are
154
exchanged for goods/services at participating merchants. Each local platform is

supported by one or more governmental agencies, motivated by a desire to improve

the transportation common good by changing commuter behaviors and by obtaining

enhanced capabilities for collecting and analyzing transportation-related data.

Table 7-3
Metropia’s Business Model

Business Model Element Description

 Provide optimal mobility solutions for going from point A to point B.
Commuter Value Proposition
 Provide reward points for contributing to the common good .
Commuter Profit Model  Subscription fees & transaction fees.
 Gain exposure with the commuter community.
Provider Value Proposition
 Gain revenue from servicing the commuter community.
Provider Profit Model  Negotiated mobility services costs.
Merchant Value Proposition  Build reputation with commuter community.
Merchant Profit Model  Exchange goods/services for reward points.
 Enhance commuting common good.
Government Agency Value
 Obtain mobility-related data.
Proposition
 Obtain knowledge from Big Data analytics.
 Revenue (from developing, launching & enhancing local market
Government Agency Profit
platforms).
Model
 License fees (from Big Data/analytics products & services).
 Traffic optimization & Big Data analytics.
Core Capabilities  Interconnect market platform with government/provider processes.
 Relationship management (all communities).
 Sensing and identifying new mobility services and providers.
Dynamic Capabilities
 Sensing and identifying new government regulations.

Strategic Intent for Network Organizations

A strategic intent directs, rather than constrains, organizations’ digital

strategists’ thought processes as competitive actions are formulated and as the

capabilities necessary for implementing these and future competitive actions are

developed. With pipeline ecosystems, strategic intents are established to emphasize

and evolve a dominant consumer value proposition – and, hence, the capabilities that

enable the value disciplines (i.e., operational excellence, customer intimacy and/or

product leadership) that underlie this value proposition. Given the multiplicity of

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

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strategic intents tend to be considerably broader than those of their pipeline

organization counterparts. In essence, network organizations’ digital strategists face

a more complex and more dynamic competitive space than do pipeline organizations’

digital strategists - think about not only juggling more balls, but balls that are

erratically moving about.

Table 7-4 illustrates the primary value propositions offered by TopCoder and

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

success of both of these organizations.

Table 7-4
TopCoder’s and Metropia’s Value Propositions

Value Disciplines
Community Value Proposition Operational Customer Product
Excellence Intimacy Leadership
TopCoder
Obtain software code that meets
Clients specifications within agreed-on schedule &
budget.
Earn income, develop skills, demonstrate
Developers skills and interact with forward-looking
community.
Metropia
Obtain optimized mobility solutions &
Commuters
reward points.
Gain exposure to and services revenue from
Providers
the commuter community.
Build reputation within the commuter
Merchants
community.
Enhance the transportation common good,
Government access a new source of traffic data, and
enhance Big Data analytic capabilities.

Market Design and Market Platform Design

The competitive moves taken by a network organization’s leadership team can

be viewed, conceptually, as focused on one of two levels of design: market design,

or moves aimed at enhancing the efficiency of the constituted market; and, market

platform design, or moves aimed at building market platform content/functionality

156
in order to enhance community participants’ satisfaction with offered value

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

primary attributes serving as each level’s focus and offering examples of competitive

moves addressing these attributes. While moves taken at either of these design

levels can affect both market efficiency and participants’ satisfaction, distinguishing

competitive moves in this manner can ease the cognitive and communication efforts

of leadership team members and of digital strategists as they formulate their

organizations’ digital strategies. It is also important to note that taken competitive

moves can be initially implemented by fully-digitalized processes (i.e., built into a

platform’s functionality) or by staff being supported through digitalized processes.

Over time, the operational and managerial processes associated with competitive

moves handled initially by humans are typically digitalized as the processes are

institutionalized.

Table 7-5
Market Design and Platform Design

Attribute Targets of Competitive Moves

Market Design
Market  Recruitment of community members.
Thickness  Retention of community members.
Market  Maintenance of an effective balance in community sizes.
Congestion  Occurrence of value-adding matches.
 Perceived fairness & trustworthiness of market transactions.
Market
 Perceived trustworthiness of platform content.
Safety
 Perceived level of platform security.
Market Platform Design
Core Transaction  Core transaction fulfillment rate.
Fulfillment  Participants’ satisfaction with community value propositions.
Ease-of-Use  Participants’ abilities to access platform functionality & content.
Data & Information  Participants’ abilities to contribute data & information.
Exchange  Participants’ abilities to interact with other participants.
 Ease of adding or removing: communities, participants, platform
Adaptability
functionalities & platform content.

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Market Design

The objective of market design is to create the conditions most conducive to

efficient market operation. Three such conditions are suggested as being most

important:41,42

 Market thickness: ensuring sufficiently large numbers of producers and

consumers such that a strong likelihood exists that satisfactory producer-
consumer matching will occur.

 Market congestion: ensuring the ease by which producers and consumers

are able to consider a sufficient number of alternatives in arriving at a
satisfactory match.

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

Let’s now look more closely at each of these market design attributes.

A classic example for understanding market thickness is that involving credit

cards. What do you, as a consumer, value in a credit card? While things like reward

programs and interest rates are obviously important, you would not even consider a

credit card unless it was accepted by most of the merchants you patronize. What

leads a merchant to decide to accept a specific credit card? While setup costs and

transaction fees are clearly important, a merchant would hesitate to invest in a card

that was not held by a sizeable portion of the merchant’s customers. Invariably, the

decision by producers or consumers (or, in general, market participants) to join a

specific network ecosystem is largely a function of the size of the cross-side

community. Successfully resolving this chicken-and-egg problem represents a major

A.E. Roth, “What Have We Learned from Market Design?,” The Economic Journal,
41

March 2008, pp. 285-310.

42
H. Tajedin, Three Essays on Crowdsourcing as a New Mode of Organizing, 2016
Doctoral Dissertation, Schulich School of Business, York University, Toronto, CA.
158
challenge for network organizations. Further, because of the learning costs borne by

participants engaging with a new market platform, ensuring sufficient market

thickness requires a simultaneous focus on attracting and on retaining participants.

Your first thoughts when hearing the term congestion is likely to bring up

images of difficulties faced by participants as they navigate through a market

platform in order to locate attractive value-unit matches. While such navigation

challenges can certainly deter market platform use and hinder market efficiency,

market congestion tends to be most problematic when the demand for available

value-units is highly skewed, resulting in too few participants being able to satisfy

their needs through a marketplace. To counter demand skewness, network

orchestrators need to undertake initiatives aimed at balancing demand by (1)

attracting or developing producers of the in-demand value-units, and/or (2)

educating consumers on how available value-units in less demand might as well

satisfy their needs.

Many potential threats to market safety arise when market participants

interact and carry out transactional exchanges via a market platform, such as:

 Is my exchange partner trustworthy?

 Is the market platform content trustworthy?

 Will all data or information I provide in carrying out a market transaction be

treated in a confidential and protected manner?

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

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

licensing concerns?

 Can I be confident that financial exchanges will be carried out in a secure

and protective environment?

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If potential market participants develop safety-related concerns, one of two things is

most likely to occur. First, many of these potential participants will simply decide not

to participate. Second, many of the participants who do decide to participate will end

up identifying, but not consummating, a match; instead, matched participants will be

motivated to consummate the match (along with associated revenue streams)

outside the market platform.

Many of the competitive moves taken by TopCoder and by Metropia have been

aimed at enriching market design, with associated market platform functionality put

in place to enable or support the taken moves. Tables 7-6 and 7-7 illustrate these

market design competitive actions for, respectively, TopCoder and Metropia.

Table 7-6
TopCoder’s Market Design Competitive Moves

Market
Primary
Design Competitive Moves
Processes
Attribute
Grow Developer  Talent teams engage in on-campus campaigns.
Thickness
Community  Talent teams run algorithm challenges (competitions).
Grow Client
Thickness  Sales teams target, market to and interact with potential clients.
Community
Enrich Developer  Account teams induce clients to offer projects requiring hot skills.
Congestion
Skills  Internal R&D offers projects requiring hot skills.
Enrich Client  Account teams broaden clients’ views of what can be done via software
Congestion
Demand development crowdsourcing and on the crowds’ capabilities.
Match Developers  Account teams work with clients to break projects into contests.
Congestion
with Contests  Account teams modify contests not attracting sufficient developers.
 Staff managers and developer co-pilots monitor projects & contests.
Enrich Solution
Safety  Staff & developer-crowd assess solution completeness/trustworthiness.
Fulfillment Safety
 Contest appeals process for non-winning developers.
 Contest reviews & project management increasingly outsourced to the
Retain Developers Thickness developer community.
 Enrich the developer community through events & developer forums.
 Long-term contracts, strong client relationships, and the provision of
Retain Clients Thickness
rich metrics regarding contest, project & client success.

160
 Table 7-7
Metropia’s Market Design Competitive Moves

Market Design
Primary Processes Competitive Moves
Attribute
 Partner with government agency in promoting
platform.
Grow Commuter Community Thickness
 Partner with an organization sponsoring a
traffic-congesting event to promote platform.
 Leverage government agency (permitting &
Add a Provider Thickness
regulatory) relationships with providers.
Grow Government &
Thickness  Establish program managers/teams.
Merchant Communities
Enrich Commuter  Programs directed at broadening commuters’
Congestion
Perspectives understandings of mobility alternatives.
Enhance Data/ Algorithms Congestion  Continual improvement
 Reengineer reward points schemes, processes
& algorithms to detect and to prevent fraud.
Enhance Platform Safety Safety
 Commuter data shared only in aggregate
forms.
Retain Commuters Thickness  Threat of losing accumulated reward points.
Retain Government Agencies Thickness  Threat of losing data/analytic capabilities.

Market Platform Design: Digitalizing the Operational Domain

Table 7-8 describes five major operational purposes of all network

organizations’ market platforms. Most of the activities listed should be familiar to

you, but one may not: ancillary transactions. As explained earlier, the core

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

consumer community together. Ancillary transactions refer to transactions

associated with the value propositions that bring communities other than producers

and consumers to the platform. Perhaps the most familiar example of this distinction

can be seen with Google. Google’s core transaction involves finding satisfactory

matches between consumers’ search cues and producers’ website content. Google’s

ancillary transactions involve the placing of and clicking on the advertisements that

show up along with search results.

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

Platform
Associated Activities
Purpose
Community  Adding a new community.
Hosting  Removing an existing community.
 Adding a new community participant.
Community
 Providing functionality & content through which participants can
Member
develop & promote their needs & capabilities.
Hosting
 Removing an existing community participant.
 Providing functionality & content enabling participants to identify
Matching
matches aligned with sought value propositions.
Facilitation
 Providing functionality enabling participants to select a match.
 Providing functionality & content to negotiate & execute
Core
transactions.
Transaction
 Providing functionality & content to verify completed
Facilitation
transactions.
 Providing functionality & content to negotiate & execute
Ancillary
transactions.
Transaction
 Providing functionality & content to verify completed
Facilitation
transactions.

A number of critical operational performance requirements are reflected in

Table 7-8: ease-of-use (simplicity, multi-channel convenience, mobility and

flexibility), efficiency in executing platform functionalities, cost-effectiveness

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

grow rapidly), and adaptability (adding/removing communities, participants,

functionalities and content). Collectively, these performance requirements dictate

that network organizations’ market platforms adopt particular architectural features:

many-to-many connectivity, modularity, the tight-coupling of modules delivering

global (i.e., used by multiple communities, including internal staff) functionalities,

and the loose-coupling of modules delivering local (i.e., used by a single community)

and experimental functionalities.

162
Market Platform Design: Digitalizing the Analytical Domain

The nature of network ecosystems – that is, communities with large numbers

of members, participants’ interaction within and between communities, participants’

navigation through the market platform provided by a network orchestrator,

participants’ transaction exchanges, etc. – results in the capture and generation of

huge amounts of data. These data can then be stored and organized for a variety of

analytical purposes, including:

 Learning about each community in order to better understand and anticipate

community members’ capabilities, perspectives, desires, needs and
expectations in order to grow/retain community members, to enhance value
propositions and to enhance profit models.

 Learning about participants’ platform navigation behaviors, as well as

participants’ use of platform functionality and content, in order to improve
ease-of-use, to enhance community value propositions and to enhance profit
models.

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

Importantly, the capabilities fashioned to undertake such analyses can be used by

network organization staff and by participants. Figures 7-3 and 7-4, respectively,

illustrate some of the ways in which TopCoder and Metropia are digitalizing the

analytical domain.

163
 Figure 7-3
Digitalizing the Analytical Domain at TopCoder

Project
Client Data
Profiles Primary Process
Performance Example
Developer Contest Data Core Data
Profiles Data

Diagnosing & predicting the success of a proposed project.

Prescribing how projects should be broken up into contests.

Example
Predicting contest success and prescribing contest modifications.
Analytic
Metrics production for contests, projects, clients, developers & matching. Processes

Project, contest & matching post-mortem analyses to identify areas for

primary process improvements and to identify hot developer skills.

Figure 7-4
Digitalizing the Analytical Domain at Metropia

Mobility Streaming
Provider Transportation Commuter Trip,
Commuter
Profiles Data Common Good,
Profiles Example
Provider &
Merchant Historical Commuter Merchant Core Data
Profiles Transportation Services Outcomes
Data Usage Data

Traffic flow modeling – overall and for each mobility service.

Scheduling routines – overall and for each mobility service.

Example
Routing routines – overall and for each mobility service.
Analytic
Determining reward points for commuter trip selections. Processes

Commuter behavior modeling.

Market Platform Design: Digitalizing the Collaborative Domain

A primary function of network organizations’ market platforms involves the

facilitation of information exchanges – between community members, between the

164
members of different communities, and between network organization staff and

members of different communities. These information exchanges are crucial, as such

exchanges enable participants to learn about offered value propositions and to decide

whether or not to participate further (and, ultimately, take advantage of offered value

propositions).

These information exchanges occur through one-to-one, one-to-many and

many-to-many connections. Importantly, establishing a connection involves much

more than providing the necessary connectivity. As these information exchanges

tend to be directed toward specific purposes (e.g., exploring or negotiating a potential

match, learning more about a value-unit or value-proposition, co-creating an idea or

value-unit, etc.), sophisticated digitalized collaboration environments are established

– environments characterized by specific functionalities, content and behavioral rules.

Given the heterogeneity present across the members of most interacting

communities, a variety of collaboration modes (messaging, social media,

conferencing and collaboration tools) are typically provided to participants. Tables

7-9 and 7-10, respectively, illustrate some of the digitalized collaboration

environments that have proved invaluable for TopCoder and Metropia.

165
 Table 7-9
Digitalizing the Collaborative Domain at TopCoder

Collaboration
Examples
Environment
 Peer-to-peer messaging: client/developer, staff/client,
Messaging & staff/developer, staff/staff, and developer/developer
Conferencing  Forums: client/developer, staff/client, and
staff/developer.
Ideas Processing  Identifying hot technology trends & skills.
 Project & contest monitoring.
 Project design (contests, deliverables).
Joint-Work  Contest software design (specifications, architecture).
Space  Contest software coding/testing.
 Assessing contest solution completeness &
trustworthiness.
 Setting contest incentives.
Decision-Making
 Modifying contests & contest incentives.
Processes
 Ranking contest solutions (selecting winners).

Table 7-10
Digitalizing the Collaborative Domain at Metropia

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

Digital Strategy Formulation

The task facing network organizations’ digital strategists is quite daunting. In

addition to having to confront many of the same strategic challenges as those facing

pipeline organizations’ digital strategists, network organizations’ digital strategists

have to design and build a market ecosystem from scratch and motivate participants

166
to engage in value-unit exchanges through the market platform. The heightened

complexity facing network organizations’ digital strategists is perhaps best

understood through the five strategic challenges summarized in Table 7-11. We

begin this section by discussing these five strategic challenges. Then, we describe

how digital strategists evolve their organizations’ business models.

Table 7-11
Network Organization Strategic Challenges

Strategic Challenges Key Issues

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

How Fast Should each Community Grow?

When a network organization first launches its market platform, the first hurdle

to overcome is the chicken & egg problem: producers only wish to participate in a

market with a large pool of potential consumers, and consumers only wish to

participate in a market with a large pool of potential producers. Table 7-12

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

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

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

existing consumers become producers (e.g., with Airbnb, short-term renters often

decide to become hosts, and hosts often become short-term renters).

Table 7-12
Tactics for Overcoming the Chicken & Egg Problem

Tactic Description
Build a producer community by incenting members to create
Follow-the-Rabbit
value-units, which in turn will attract a consumer community.
Connect with members of an existing community - either a
Piggy-Back producer community to gain access to value-units or a
consumer community (if value-units already exist).
Attract an ancillary community by first growing the producer
Seeding and/or consumer community to which the ancillary community
is attracted.
Provide incentives to attract highly-visible and influential
Marquee participants (producers or consumers), whose presence attracts
other participants.
Begin as a pipeline organization to build a targeted producer or
Pipeline consumer community; then, attract other communities desiring
to interact with this first community.
Big-Bang Invest heavily in traditional push marketing strategies to
Marketing attract the communities critical to the in-play business model.
Begin by targeting a niche market whose producer & consumer
Micromarketing
communities are already interacting.

However, if one side grows too fast, negative network effects are felt: too

many consumers leads to insufficient supply, resulting in unsatisfied consumers; too

many producers leads to insufficient demand, resulting in unsatisfied producers. It

can be difficult, if not impossible, to retain or to regain an unsatisfied participant.

How can the threat of negative same-side network effects be managed? Three

common tactics are (1) invest in growing an undersized community, (2) impose rules

43
G.G. Parker, M.W. Van Alstyne and S.P. Choudhury, Platform Revolution: How
Networked Markets are Transforming the Economy – And How to Make Them Work for You,
2016, New York: W. W. Norton.

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that constrain the behaviors of members of the oversized community (e.g., limit the

number of allowed transactions), and (3) segment the market so as to increase the

likelihood of successful matches within each segment.

What Pricing Mechanisms Should Be Applied to each Community?

With few exceptions, communities are brought to a network organization’s

market platform for one of two reasons: to serve as a revenue source (a money-

side), and to attract other communities that can serve as revenue sources (a subsidy-

side). Determining an appropriate profit model for each community is critical because

of the powerful growth dynamics of network ecosystems:

 Charging (or charging too much) for access will limit or reduce community
size.

 Charging (or charging too much) for feature use will inhibit participants’
engagement with the business platform.

 Charging (or charging too much) for value-units will reduce demand.

 Charging (or charging too much) for production will reduce supply.

Generally, pricing mechanisms are imposed on the members of a community when

these members are able to use the market platform to extract value from the

members of another community. The greater the value being appropriated, the

greater the price that can be imposed.

Often, pricing mechanisms can also be imposed on subsidy-side communities,

providing a revenue stream from the subsidy-side. This can occur if the value

proposition is highly-attractive and unique (i.e., not available elsewhere), and if these

subsidy-side community members are likely to accept some level of access/usage

charges. That said, it is wise to never charge any participant for services he/she has

become accustomed to receiving for free. Instead, add new features to the value

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proposition, attach the charges to these new features, and continue to make the

base-level (initial) features available for free to community members.

Should a New Feature Be Added?

An infinite variety (limited only by creativity and capability) of new, ideally

innovative, features can be added to a market platform to enhance the value

propositions offered to the platform’s interacting communities. Generally, these

deliberations about new features are quite straightforward: add any new feature

whose acquisition and implementation costs are less than the value being created.

However, if the new feature being considered is not viewed as a benefit by all

communities or, even worse, if the new feature portends to bring some participants

in conflict with other participants, this decision can become quite challenging. In

such situations, the trade-offs to be reasoned across communities can be extremely

difficult to navigate, especially prior to the new feature’s actual implementation. For

this reason, network organizations often engage in strategic experimentation to

assess the likely impacts of new platform features. With a strategic experiment, a

new feature is implemented – but only for a limited set of participants and a limited

set of transactions – and relevant data is captured that can be analyzed in

determining the positive and negative impacts of the feature. Further, digital

strategists need to recognize that short-term revenue gains (from one community)

may need to be bypassed so as not to alienate participants (from another community)

and that it is not always best to favor the community that brings in the largest share

of current revenues, as this community may not be the most important source of

future revenues.

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Should Transactions and Participant Behaviors Be Regulated?

Some regulation is indispensable as a means for preventing market failures,

i.e., an improperly-functioning (or collapsing) network ecosystem:

 Insufficient information and transparency in the market with respect to the

value-units and payments being exchanged can result in low-quality
participants driving out high-quality participants.

 Excessive competition within an interacting community or an unwillingness

by a community’s members to maintain their capabilities reduces the value
being created in the market and, hence, the market’s attractiveness to other
interacting communities.

Accordingly, network organizations develop regulations targeted at participants’ use

of a market platform’s content and functionalities.

These regulations are most often imposed to force a trade-off of quality over

quantity. The strength of any cross-side network effect is ultimately a function of

the number and the quality of the market exchanges taking place. If, over time, a

growing proportion of market exchanges are seen by participants as decreasing or of

low quality, the positive cross-side effect will attenuate – eventually becoming a

negative cross-side effect that results in the market’s collapse.

How Many Communities Should Connect to the Market Platform?

The advantages of attracting a new community to a network ecosystem’s

market platform are often very appealing to digital strategists. The addition of a new

community raises the promise of additional positive cross-side network effects, the

promise of a new revenue source, and the promise of greater scale.

However, adding a new community does not always result in positive

outcomes. If not mindfully thought out and carefully timed, a new community can

produce: negative cross-side network effects (when the new community’s value

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proposition conflicts with aspects of the value propositions of one or more existing

communities), increased operational and strategic complexity, and increased

operational costs. Further, a tendency exists for innovativeness to be dampened as

additional communities are added. Here, the radicalness of a functional innovation

targeted at one community is toned down to maintain the acceptability of the

functionality to other communities, appropriating little value from this functionality

enhancement.

Evolving Network Organizations’ Business Models

The strategic challenges summarized in Table 7-11 serve as a backdrop that

pervades digital strategists’ deliberations as they evolve their organizations’ business

models via competitive moves targeting market design, market platform design, or

both. Figure 7-5 overviews the factors typically considered in fashioning specific

competitive moves.

Figure 7-5
Factors Driving Business Model Evolution

 Natures of adjacent (competitive

& substitute) markets
 Adjacent market business model
innovations
 Socioeconomic & cultural trends
Strategic Intent

Beliefs about:
 Communities’ needs & Business Model Deliberations
desires  Number of communities
 The core transaction &  Value propositions Business Model
adjacent transactions  Profit models Evolution
 Same-side & cross-side  Core capabilities
network effects  Dynamic capabilities
 Core capabilities
 Dominant value
discipline(s)
 Installed platforms
 Held digitization capabilities
 New digital technologies
 Others’ digitalization innovations

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 A taken competitive move typically affects multiple elements of a business

model. Table 7-13 organizes a sample of TopCoder’s competitive moves by the

primary business model element affected. Examples of this include:

 Having platform-related R&D carried out by the developer community via

contests both incents developers to participate in the market and develops
their capabilities. In addition, the R&D project outcomes produce
functionality improvements that can enhance the client communities’ value
proposition, as well as TopCoder’s capabilities and the community profit
models.

 Providing incentives for non-winning developers clearly enhances the

developer community value proposition, thus finding more developers willing
to invest their time and effort in contests (and in the process honing their
capabilities by participating in a greater variety of contests). The client
community value proposition is also enhanced, as retaining and honing the
capabilities of the developer community increases the likelihoods that
matches will be found for clients’ projects and that these projects will be
satisfactorily fulfilled. Finally, by growing the developer and client
communities and by improving project fulfillment rates, TopCoder’s
community profit models are likely to improve.

The above examples illustrate that a taken action targeted at one purpose often spills

over to affect other purposes. It is important to remember that such spillovers are

not always positive. Clearly, fashioning successful competitive moves for network

organizations requires considerable analysis – that often must be performed quickly

and imprecisely given the fast-moving dynamics of network ecosystems.

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 Table 7-13
Examples of TopCoder’s Competitive Moves

Business Model
Business Model Evolution
Element
Communities None observed.
 Platform R&D carried out as contests.
 Transferring software development management tasks (contest-
co-pilot, solution assessment, solution appeals process, etc.) to
the crowd.
Value Propositions  Incentives to ensure winners of a project’s completed contests
are available to interact with participants in the project’s
subsequent contests.
 Crowd-engaged appeals process regarding winning solutions.
 Imposing a 30-day time period for vetting winning solutions.
Profit Models  Incentives provided for non-winning developers.
 Contest success prediction.
 Contest fulfillment.
Core Capabilities  Client capability development.
 Crowd skill development.
 Develop crowd into a community.
Dynamic Capabilities None observed.

Table 7-14 similarly lists some of Metropia’s competitive moves directed at

specific business model elements. Which of these are likely to spillover to other

business model elements?

Table 7-14
Examples of Metropia’s Competitive Moves

Business Model
Element
Business Model Evolution
 Host private mobility service markets (e.g., car-pooling, ride-sharing,
Communities
etc.) for use by a specific organization’s employees.
 No platform subscription fees for commuters at initial launch.
 Develop a personalized mobility health checkup functionality that
uses data on a commuter’s commuting behavior to broaden the
Value commuter’s mobility perspectives and to offer the commuter
Propositions customized trip solutions.
 Customized consulting services for government agencies.
 Customized performance reports provided to participating
commuters, providers, merchants & government agencies.
 Commuter subscription fees added as a local platform matures, the
Profit Models platform’s portfolio of mobility services broadens, and commuter
platform interactions are personalized.
 Big Data transportation analytics consulting services.
Core Capabilities
 Commuter & government agency capability development.
Dynamic
None observed.
Capabilities

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Sustaining a Network Organization’s Competitive Position

Two pathways exist for sustaining a network organization’s market position,

with the preferred path depending on whether or not winner-take-all market

dynamics apply:

 Winner-take-all market dynamics - apply: act quickly to become one of the

two or three dominant firms in the market space and then sustain this
market position.

 Winner-take-all market dynamics - do not apply: grow both the market

space and the firm’s share of the market space more deliberately by
evolving a business model that becomes increasingly attractive to all
interacting communities, and then sustains (or increases) this market
position.

Our focus here is on sustaining a strong market position in the face of the constant

threat of digital disruption, regardless of the above market-position pathways.

Perhaps this most important insight for digital strategists is the realization that

a focus on just amplifying positive cross-side network effects cannot guarantee the

barriers to entry that protect a firm from existing competitors and from new entrants.

Attention must also be directed at finding ways to:

 Impose switching costs on participants.

 Drive down market platform costs (the average costs to host communities,
to facilitate participant interactions, and to execute transactions), thus
making it cost-prohibitive for new entrants to enter the market space.

 Continuously improve market platform ease-of-use.

 Introduce business model innovations, especially those related to community

value propositions and profit models.

 Quickly imitate (ideally with enhancements) competitors’ and new entrants’

business model innovations.

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Network ecosystems are powerful and hard-to-replicate because of their inherent

community dynamics. However, achieving and then sustaining a strong market

position is difficult, requiring high levels of both strategic vigilance and creativity.

A Recap and Look Ahead

While network organizations represent a smaller share of nations’ GNPs than

do their pipeline organization counterparts, this rapidly growing segment of most

nations’ economies is spurring much of the digital innovation (and digital disruption)

being observed today. This chapter has described how digitalization is applied within

network organizations, as well as the processes used by network organizations to

formulate their digital strategies.

While well-reasoned digital strategies have become a dominant driver of

competitive success for both pipeline organizations and network organizations, the

pervasive digitalization that results can raise serious threats for organizations’

leadership teams. The next chapter examines these threats, and the tactics being

applied to attenuate the threats.

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 Chapter 8. Grappling with the Risks of Digitalization

The enabling nature of digital disruption might best be captured by three ideas:

pervasive digitization, pervasive connectivity and pervasive mobility. Invariably,

pipeline ecosystem participants and network ecosystem participants find themselves

constantly accessing and exchanging digitized content (e.g., data, information,

goods, services and currencies) and it is precisely these type of activities that are

creating an abundance of competitive opportunities for digital strategists able to act

smartly and nimbly.

However, the technological underpinnings of organizations’ digital strategies

also pose significant strategic risks. If digitalization risks are not appropriately

addressed by organizations’ leadership teams, the competitive wins that are realized

are likely to be short-lived, at best. Consider what happened in January 2003 when

a small (376 bytes) data virus infected a single processing device with the Slammer

worm.44 After launching itself onto the Internet, it infected close to 100,000 large

computer systems worldwide in just 30 minutes. The impact was chilling: air and rail

transport were delayed, electrical and pipeline utilities were interrupted, ATMs were

disabled, call centers were shut down, etc. In today’s highly digitized, connected and

mobile world, a single person’s lapse can quickly spread across the platforms to which

the person is directly or indirectly connected.

Nothing demonstrates the challenges presented to digital strategists better

than the paradox surrounding the capture and use of personal data. Data privacy

44T. Goles, G. White and G. Dietriech, “Dark Screen: An Exercise in Cyber Security,”
MIS Quarterly Executive, June 2005, pp. 303-318.
177
concerns exist wherever personally-identifiable or other sensitive information is

captured, collected, stored and used. That said, tomorrow’s waves of digitalization

innovation and growth will surely involve intelligent analytics, highly-customized

goods and services, and always-available mobile connectivity offering one-touch

transactions, where these transactions require the collection and use of vast

quantities of personal data: socio-demographic data, location data, transaction

histories, etc. People can be motivated – through the expectation that the value of

the goods and services obtained will outweigh potential liabilities – to allow the

capture and collection of these data, but only if trust is established and maintained

that any collected personal data will be protected and will not be used in the absence

of permission to do so.

A key factor differentiating those organizations able to successfully exploit

digitalization for competitive purposes is a set of strong capabilities for managing

digitalization risk. Supporting evidence for the value of managing digitalization risk

is illustrated by a study that found voluntary disclosures of initiatives aimed at

reducing digitalization risks improved organizations’ stock prices by, on average,

6%.45 Effective digitalization risk management, however, involves much more than

enhancing an organization’s cybersecurity. The real challenge is to achieve an

effective balance in stability (as evidenced by efficient, secure, reliable and available

platforms) and agility (as evidenced by a readiness to formulate and implement

timely and innovative competitive moves).

45L. Gordon, M. Loeb and T. Sohail, “Market Value of Voluntary Disclosures Concerning
Information Security,” MIS Quarterly, September 2010, pp. 567-594.
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 Managing digitalization risks in a manner that balances stability and agility is

a participation sport that demands the involvement of all of an organization’s

members. With the aim of providing a mindset and a foundation conducive for

effectively managing digitalization risk, this chapter covers the following topics:

 Nature of Digitalization Risks

 Risk Management: A General Overview

 Digitalization Risk Management Practices

 The Board of Directors and Digitalization Risk Management

 Accounting for Digitalization Risks in Digital Strategy Formulation

Nature of Digitalization Risks

A digitalization risk refers to the likely occurrence of digitalization-related

incidents that have the potential to negatively impact an organization’s operational

performance and/or competitive position. What are these negative impacts? A useful

way of thinking about these negative effects is the following loss categories:

 Financial loss: theft; fraud; extortion; destruction of uninsured facilities,

equipment and materials; drops in stock valuations; regulatory fines; legal
fees, court awards and out-of-court settlements; etc.

 Revenue loss: short-falls in revenue streams or lost revenue streams

traced to operational disruptions, reputation loss, the inability to respond
effectively to competitors’ actions, etc.

 Intellectual property loss: thefts of digitized ideas, innovations and other

forms of creative expression (e.g., trade secrets, blueprints, digitalized
processes, proprietary digital content, digital strategies, business models,
etc.).

 Reputation loss: depreciation of an organization’s image or of its brands

that undermines the trust and goodwill held by participants in the various
market-focused ecosystems with which the organization participates.

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These negative impacts can be huge. Consider, for example, the losses suffered by

the TJX Companies after a security breach46 (reported in late 2006) that enabled

hackers to obtain data from over 45 million customer payment cards.47 Access into

the TJX Companies’ s business platform was gained by digitally eavesdropping on the

POS transactions associated with the in-store customer return process. It has been

estimated that the direct costs (the largest portion of which involved contacting and

offering assistance to affected customers) to the TJX Companies for the breach might

have been as high as $1.6 billion.48 Other of these direct costs involved obtaining

legal advice, internal investigations, public relations and regulatory fines. However,

these direct costs do not include the very sizeable revenue and stock valuation losses

that occurred during 2007.

Figure 8-1 provides a visual framework simplifying the complexities of the

digitalization risk context. Here, three entities are brought together: a set of threats,

a set of targets, and the actors most significantly associated with the occurrence of

digitalization-risk incidents. Table 8-1 lists the loss categories typically associated

with each of the types of threats and targets.

46
A security breach refers to an incident that results in the confirmed disclosure of
data to an unauthorized third-party.
47
W. Xu, G. Grant, H. Nguyen and X. Dai, “Security Breach: The Case of TJX
Companies, Inc.,” Communications of the Association of Information Systems, Vol. 23,
November 2008, pp. 575-590.
48
C.R. Speechlys, “The Real Cost of a Data Breach,” Lexology, November 12, 2012:
http://www.lexology.com/library/detail.aspx?g=2aaa771a-2523-4e60-a0bc-306db8323d0e
180
 Figure 8-1
Framing the Digitalization Risk Context

Threats
Malicious Natural Legal & New Digital Actions of a External Inability to
Intrusion Disaster Regulatory Technology Competitor Sourcing Respond

Outsiders
Cybercriminals
Terrorists
Hacktavists
Digitalization Risks
Actors

Ecosystem Participants

Insiders
Employees
Senior Executives

Business Platform Digital Internal Platform Digitalization

Operations Assets Controls Architectures Capabilities
Targets

Table 8-1
Losses Typically Associated with Digitalization-Risk Threats and Targets

Loss Categories
Threats
Malicious Intrusion Financial, Revenue, Intellectual Property, Reputation
Natural Disasters Financial, Revenue, Intellectual Property, Reputation
Legal & Regulatory Financial, Revenue, Reputation
New Digital Technology Revenue, Reputation
Actions of a Competitor Revenue, Reputation
External Sourcing Financial, Revenue, Intellectual Property, Reputation
Inability to Respond Revenue, Intellectual Property, Reputation
Targets
Business Platform Operations Revenue, Reputation
Digital Assets Financial, Revenue, Intellectual Property, Reputation
Internal Controls Financial, Reputation
Platform Architectures Financial, Revenue, Reputation
Digitalization Capabilities Financial, Revenue, Reputation

Let’s take a look at the actors (described in Table 8-2). Actors are associated

with threat incidents in two ways. Most often, actors are thought of as the

perpetrators of malicious intrusions – or, acts of commission. Cybercriminals (by

181
far the most common type of perpetrator), terrorists and hactavists clearly

instigate digitalization-risk incidents, as can ecosystem participants and

organizations’ employees (either acting alone or collaborating with others).

Table 8-2
Actors Associated with Digitalization-Risk Incidents

Actor Description
Outsider
Uses hacking techniques & tools in order to take illegal actions for financial
Cybercriminal gain or to take over digital assets in order to launch a series of illegal
actions.
Uses hacking techniques & tools for the purpose of causing harm & havoc
Terrorist
within an established geo-political order.
Uses hacking techniques & tools for the purpose of bringing attention to a
Hactavist
social or political issue.
Pipeline ecosystem participants (suppliers, upstream intermediaries,
downstream intermediaries, consumers) and network ecosystem
Ecosystem
participants (members of interacting communities), who connect to
Participant organizations’ business/market platforms to facilitate ecosystem
transactions.
Insider
Operational, staff & managerial employees, who connect to the
Employee
organization’s business platform to carry out their work roles.
Members of the leadership team, whom are collectively responsible for:
seeding & overseeing digital strategy formulation & implementation, setting
Senior Executive
policies for digitalization, and allocating the resources necessary for
effective digitalization.

Just as serious, though typically overlooked, are the acts of omission traced

back to organizations’ employees and senior executives. It is not uncommon for

employees to claim ignorance of their organizations’ digitalization-risk

policies/procedures or to be lax in following these policies/procedures. Because of

employees’ acts of omission, organizations experience greater likelihoods of

experiencing losses regarding three, in particular, digitization-risk incidents:

malicious intrusion, natural disasters and legal/regulatory violations. Even more

problematic, it is not uncommon for organizations’ most senior executives to abdicate

some, if not most, of their managerial and fiduciary responsibilities regarding seeding

and overseeing digital strategy formulation and implementation, setting policies for

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digitalization, and for allocating the resources necessary for effective digitalization.49

Because of senior executives’ acts of omission, organizations have a greater

likelihood of experiencing incidents regarding all nine digitization-risk threats.

Figure 8-2 illustrates the relationships between threats and targets. Acts of

commission, i.e., malicious intrusion, are most often directed at two threat targets:

business platform operations and digital assets. Business platform operations

refers to the execution of an organization’s digitalized operational and managerial

processes that are hosted on business platforms (and on market platforms); and,

digital assets refer to the digital technologies (hardware and software), digitized

data, and digitization/digitalization capabilities applied in configuring digital platforms

and business platforms. The most common incidents directed at business platform

operations are denial-of-service attacks, where the aim is to disrupt business

continuity either by flooding a platform with transactions, dramatically increasing

transaction volumes (slowing response times) or by inserting a virus that damages

the processing being performed on a platform (hence, shutting down the platform or

producing processing faults that result in the platform being shut down for repair).

The most common incidents directed at digital assets involve theft of digital content,

with content then being used for criminal or business-espionage purposes.

A. Masli, V. Richardson, M.W. Watson and R.W. Zmud, “Senior Executives IT

49

Management Responsibilities: Serious IT-Related Deficiencies and CEO/CFO Turnover,

Management Information Systems Quarterly, September 2016, pp. 687-708.
183
 Figure 8-2
Associations Between Threats and Targets

Malicious Natural Legal & New Digital Actions of External Inability to

Intrusion Disaster Regulatory Technology Competitors Sourcing Respond

Business Platform Digital Internal Platform Digitalization

Operations Assets Controls Architectures Capabilities

Acts of omission play out across all five threat targets as needed digitalization-

related investments and policies are either not pursued or pursued ineffectively and

as sanctioned digitalization-related investments and policies are poorly implemented

and/or followed. The consequences of not attending to business platform operations

and to digital assets were addressed in the preceding paragraph. An organization’s

internal controls refer to the processing logic and rules embedded within digitalized

financial reporting systems to ensure the correct handling of financial transactions

and the accuracy of produced financial reports. If an organization’s internal controls

are in error or incomplete, the organization’s financial systems are susceptible to

malicious intrusions and the organization – along with its CEO and CFO – are subject

to penalties under the Sarbanes-Oxley Act. If organizations’ platform architectures

are not designed and maintained so as to remain aligned with these organizations’

digital strategies, it is unlikely that appropriate stability/agility balances can be

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achieved. Finally, organizations lacking the digitalization capabilities to quickly

respond to competitors’ actions or to introduce innovative business models are

unlikely to maintain, let alone enhance, their competitive positions.

Prior to moving on to discussions of risk management and risk management

tactics, let’s briefly examine each of the digitalization-risk threats.

Malicious Intrusions

A malicious intrusion refers to a perpetrator’s success in getting through an

organization’s security-related defenses, i.e., the systems software and digitalized

work procedures aimed at identifying and authenticating all physical and digitized

attempts to access an organization’s digitalized business platforms and digital assets.

Successful intrusion usually begins via either phishing or through a POS device, but

then moves on to a wide gamut of abuses: theft, fraud, sabotage, denial-of-service

attacks, viruses, worms, website defacement, electronic eavesdropping, etc. As

these perpetrators and the hacking tools and techniques they use get better and

better, the time it takes to compromise a victim just gets shorter and shorter.

Today’s public and private digital infrastructures are becoming so large and so

complex that they are beyond the control of any one organization. As a result, no

matter how prudently an organization moves forward with security policies,

procedures and programs, the organization remains exposed to the threat of

malicious intrusion. The objective should not be to prevent all malicious intrusions,

but rather to prevent less-sophisticated intrusion attempts and to minimize the

damage caused by more-sophisticated intrusion attempts through quick detection,

removal and repair.

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Natural Disasters

Natural disasters (e.g., tornadoes, hurricanes, earthquakes, tsunamis,

nuclear emergencies, collapsed dams, broken gas or water pipes, etc.), are worst-

case scenarios for any organization. If affected directly by a natural disaster,

business operations might be nonfunctional for days, weeks or months – resulting in

significant, if not catastrophic, revenue losses. Even if affected only indirectly by a

natural disaster, most organizations are likely to suffer some disruption to their

inbound/outbound logistics flows. While it is impossible to predict the occurrence of

such events, all organizations need to be prepared to act to minimize the effects of

and quickly recover from any operational disruptions. The implications of critical

business platforms becoming unavailable can be devastating, especially as ever-

greater portions of organizations’ business processes – the lifeblood of most

organizations’ revenue streams – are digitalized.

As natural disasters are unpreventable, the digitalization risk emphasis is on

achieving a graceful degradation in platform operational performance and a quick

recovery. Graceful degradation means that operations affected by a natural

disaster do not immediately shut down, but instead gradually slow down, allowing

time for affected operations to be shifted to other physical locations prior to a

complete shutdown. Both graceful degradation and quick recovery are typically

achieved by designing multiple redundancies into operational sites and activities. For

example, the physical sites housing digitalization operations are outfitted with backup

power systems, have all platform content (data and software) backed up on a regular

basis (say, every two hours) at a distant recovery site, and might even have all

processing activity instantly mimicked at the distant recovery site.

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Legal and Regulatory Requirements

Organizations today face a broad array of digitalization-related legal and

regulatory requirements requiring protective actions most often aimed at

preventing harm to others. Included among these regulations, that originate from

federal, state and local governmental agencies, are those aimed at:

 Protecting personal data (about customers, employees, visitors, etc.) that is

collected, held, processed and provided to others.

 Ensuring the security and accuracy of financial transactions and reports.

 Requiring data collection and information reporting by organizations whose

products, services and work activities are environmentally-sensitive.

 Requiring data collection and information reporting by organizations whose

products, services and work activities are potentially harmful to consumers
or employees.

Organizations (and, possibly, specific employees) found noncompliant with statutory

requirements can suffer legal and civil penalties, as well as significant reputation

losses.

What makes the digitalization-related environments especially confusing and

complex is that the nature of regulations (statutory versus voluntary, breadth and

depth of coverage, sanctions for noncompliance, etc.) varies considerably across geo-

political boundaries (e.g., cities, states, nations, the EU, etc.). Table 8-3 describes a

few of the more well-known digitalization-related regulations facing U.S.

organizations.

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 Table 8-3
Examples of U.S. Digitalization-Related Regulations

Regulation Description
Educational agencies & institutions receiving funding from the U. S.
Department of Education are required to provide students with
Family Educational Rights
access to their education records, an opportunity to seek to have the
& Privacy Act of 1974
records amended, and some control over the disclosure of
information from the records.
Health care providers, insurance providers and employers are
Health Insurance Portability
required to safeguard the security & privacy of patients’ health
& Accountability Act of 1996
records and personal data.
Gramm-Leach-Bliley Financial institutions are required to protect the security & privacy of
Act of 1999 the financial information that they collect, hold and process.
Publicly traded companies are required to provide assurance of the
Sarbanes-Oxley Act of 2002
security, accuracy & reliability of their financial reporting systems.
State Security Breach 50 States have enacted Security Breach Notification laws requiring
Notification Law (First enacted businesses to make notifications regarding security breaches.
by California in 2002) While no similar Federal law exists, bills have been introduced.
Created by the Payment Card Industry Security Standards Council,
Payment Card Industry this standard applies to all institutions that hold, process or
Data Security Standard exchange cardholder information. The standard strives to prevent
(Initially released in 2004) credit card fraud through increased controls around data and its
exposure to compromise.

New Digital Technologies

The continued advancements with digital technologies result in seeming

endless arrivals of innovative digital products and services, as well as innovative

digitalized solutions from both established and new vendors. While all new

technologies are largely untested when first released, those organizations able and

willing to subject a seemingly-relevant new technology to early assessment and

experimentation stand to gain the most from adopting that technology. Likewise,

those organizations that delay their assessing of what turns out to be a game-

changing technology are likely to have dug themselves into a deep competitive hole.

Actions of Competitors

The business model enhancements and innovations of established

organizations and startups pose a constant threat to any organization. While this has
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always been the case, what is new today is the rapidity with which competitively-

meaningful actions appear and the fact that the organizations taking action

increasingly lie beyond the boundaries of the primary market ecosystems within

which an organization participates.

What is perhaps most insidious are the rapid inroads that a new competitor

can achieve regarding market share. This can be especially damaging when an

innovative business model creates a protectable, highly-profitable niche within an

existing market, subsequently drawing away participants from established

competitors and attracting a majority of new market participants.

External Sourcing

Most typically, an externalized capability takes the form of a digitalized process

developed by a provider (or another third-party) hosted on the provider’s business

platform and accessed by the client via public or private Internet connections. When

managed well, external sourcing provides an organization with significant cost,

operational and strategic benefits. But, along with these benefits comes a heightened

exposure to digitalization risk. Table 8-4 lists the digitalization risks, organized by

target, most commonly attributed to external sourcing.

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 Table 8-4
Digitalization Risks Associated with External Sourcing

Target Digitalization Risks

Business  Operational gains (efficiency, security, scalability, etc.) not
Platform realized.
Operations  Provider platforms insufficiently enhanced, over time.
 Provider platforms lack sufficient security.
Digital Assets  Data captured by or created by externally-hosted processes are
typically owned by the provider (unless otherwise negotiated).
Internal  Processes executed on provider platform lack sufficient
Controls transaction & reporting integrity.
 Provider platform architectures insufficiently enhanced, over
Platform time.
Architectures  Provider platform architectures lose, over time, an acceptable
stability/agility balance.
 Loss of internal-to-the-client digitalization capabilities.
Digitalization
 Provider fails to enhance digitalization capabilities.
Capabilities
 Provider fails to transfer new digitalization capabilities.

Inability to Respond

The most debilitating digitization risk – though the risk that perhaps receives

the least attention – is the inability to respond to competitors’ actions. Given the

power of network effects (affecting consumer communities in pipeline ecosystems

and all communities in network ecosystems), organizations must act effectively and

quickly to meet or, ideally, to advance competitors’ competitive actions. An

organization failing to act or acting in an ineffective or untimely manner is sure to

suffer some erosion in market position – an erosion that will only spiral in the face of

a continuing stream of competitors’ actions.

What is the root cause of an inability to respond to a competitor’s action? A

number of factors come to mind:

 A delay in becoming aware of the competitor’s action.

 An incomplete understanding of the competitor’s business model.

 An incomplete understanding of how the competitor executed the

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 competitive action.

 Inconsistencies between in-place platform architectures and the

architectures needed to implement an effective response.

 Deficiencies in one or more of the platforms needed to implement an

effective response.

 Deficiencies in one or more of the digital assets needed to implement an

effective response.

 Deficiencies in one or more of the capabilities needed to implement an

effective response.

 Delays encountered in resolving deficiencies in platforms, digital assets and

capabilities.

And, as might be expected, failure to respond in an effective and timely manner

increases when more than one of these factors apply to the situation-at-hand.

Risk Management: A General Overview

Risk management is a topic that applies across all aspects of organizational

life, including digitalization. The aim of this section is to provide a general

introduction to the topic area.

It is important to recognize, first of all, that the intent of risk management is

not to eliminate risks, but to manage risks. Risk is an inherent aspect of

organizational life. While we can perfectly predict how an engineered system will

perform, it is impossible to perfectly predict how humans (e.g., operational

employees, managers, executives, consumers, suppliers’ employees, intermediaries’

employees, consultants, etc.) will perform. And, even if you could predict human

behavior by limiting the available choices, would you want to? Investments

promising high returns are generally riskier than investments promising low returns

precisely because we cannot predict the outcomes of high-return investments very

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well. By limiting the choices available to humans, you also limit the potential for

individuals to act creatively and innovatively.

Risk management strives to accomplish two objectives: creating awareness

and a common understanding across an organization’s members about the existence

and nature of a risk domain; and, putting in place risk management policies,

procedures and programs to ensure that the critical risks in the domain are

appropriately addressed by appropriate individuals. In accomplishing these

objectives, risk management involves three activities: risk planning, risk assessment

and ongoing risk control.

Risk Planning

Risk planning establishes the contexts within which risk management

activities are carried out. Risk planning begins by identifying and categorizing the

areas of risk most likely to affect an organization. Next, each risk area is assigned

an owner. It is the risk owner’s responsibility to perform regular risk assessments,

and to actively manage associated risks. Then, overall risk management policies

need to be developed that provide a context within which risk owners can implement

area-specific risk management policies, procedures and programs. Finally, high-level

objectives are devised to articulate the importance of risk management. Examples

of such high-level objectives might include:50 “Protecting the integrity and security

of client and corporate information is the responsibility of every employee.”; and,

50
Adapted from: H.A. Smith and J. McKeen, “Developments in Practice XXXIII: A
Holistic Approach to Managing IT-based Risk,” Communications of the AIS, December 2009,
p. 525.
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“We need to embed an attention to digitalization risk management into all work

processes, business functions, work roles and positions, and employees.”

Risk Assessment

During risk assessment, each risk owner, usually with the support of in-

house experts and external consultants, estimates the risk exposure associated

with each of the risk areas for which the owner is responsible. Usually, some variant

of the following formula is used:

Risk Exposure = (Probability of Risk Occurring) X (Expected Loss If

Risk Occurs)

Organizations specializing in overall or domain-specific risk management have

considerable knowledge, experience and data that can be tapped to produce

estimates of risk probabilities and expected losses. Just remember that these generic

estimates are only starting points that need to be tailored to the nuances of a given

organization and that expected losses should include both tangible and intangible

losses, as well as short-term and long-term losses. The risk of underestimating

expected losses is that an organization is then likely to under-invest in risk-related

policies, procedures and programs.

Once a risk area has been assessed, the owner must decide (again, with input

from others) how risks are to be addressed. Three actions are possible, alone or in

combination:

 Risk assumption: Accepting that losses are likely to arise if and when an
incident occurs in a risk area, covering these losses through internal funds
and third-party insurance.

 Risk deterrence: Taking action to reduce the likelihood that an incident will
occur in a risk area.

 Ongoing risk control: Monitoring a risk area such that the incident
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 occurrences are detected and resolved before excessive losses occur.

The risk assessment matrix shown as Figure 8-3 provides general guidance on

selecting an appropriate strategy for a risk area. Risk areas with low incident

probabilities and low expected losses can reasonably be assumed without taking

further action, while risk areas with high incident probabilities and high expected

losses require sophisticated strategies involving combinations of risk assumption, risk

deterrence and ongoing risk control.

Figure 8-3
Risk Assessment Matrix

Take preemptive action to Take preemptive action

reduce the incident to reduce the incident
High Monitor continuously
likelihood likelihood
to immediately
mitigate detected risk
Monitor continuously to Monitor continuously to
incidents
immediately mitigate immediately mitigate
detected risk incidents detected risk incidents
Take preemptive action
Medium to reduce the incident
Monitor regularly to Monitor continuously to likelihood
mitigate detected risk immediately mitigate
incidents detected risk incidents Monitor continuously to
immediately mitigate
detected risk events
Low
Monitor regularly to Monitor continuously to
Simply assume the risk mitigate detected risk immediately mitigate
incidents detected risk events

Low Medium High

Expected Loss If a Risk Event Occurs

Ongoing Risk Control

Ongoing risk control involves monitoring for risk incidents, detecting that an

incident is about to occur (ideally) or has occurred (more likely), and taking action to

mitigate any losses arising from the incident. Risk mitigation involves tempering

(as much as possible) the consequences of a risk incident by taking corrective actions.

Prior to implementing ongoing control procedures, the risk owner needs to determine

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the level of cost and effort to put into the procedures. Figure 8-4 illustrates the

complexity of this decision. The rational risk owner desires to neither under-invest

or over-invest in ongoing risk control. Here, again, heavy use is made of others’

knowledge and experience.

Figure 8-4
Determining the Cost of Ongoing Risk Control

Cost of Risk
Cost Deterrence/Mitigation

Sweet
Spot
Expected loss in the
Absence of Risk
Deterrence/Mitigation

Risk

An Exercise in Digitalization Risk Assessment51

An important element of the Coors Brewing Company’s marketing strategy

involves having retailers place eye-catching point-of-sales (POS) displays in their

stores. In implementing this strategy, Coors works with third-party marketing

partners and third-party providers to produce these display materials. However,

Coors owns the business processes that engage distributors and retailers in ordering

these POS display items. To motivate POS display orders, Coors provides each

51
This hypothetical exercise (used for illustrative purposes only) was developed by the
authors based on material from: J. Buffington and D.J. McCubbery, “Coors Brewing Company
Point of Sales Application Suite: Winning Mindshare with Customers, Retailers, and
Distributors,” Communications of the AIS, Volume 13, 2004, pp. 81-96.
195
wholesaler and retailer with a budget that can only be used to order POS display

items. Coors anticipates that at least some of the wholesalers and retailers will find

the display materials valuable in their efforts to increase sales and, in turn, that they

will order (display materials) beyond the Coors-provided funding.

Coors’ solution for digitalizing the business processes enabling distributors and

retailers to order promotional materials involved the building of a local (loosely

connected to other business platforms) business platform hosting five sets of

functionalities:

 Internet Interaction Portal: Enables distributors and retailers to

communicate with Coors and to gain access to the digitized business
processes.

 Ordering General Materials: Enables distributors and retailers to order

general promotional materials.

 Ordering Licensed Materials: Enables distributors and retailers to order

licensed (i.e., NFL logos) promotional materials.

 Ordering Customized Materials: Enables distributors and retailers to design

and order customized promotional materials.

 Retail Store Display Placement: Enables distributors and retailers to visualize

and optimize, through the use of digitalized tools, the physical placement of
promotional materials within a retail store.

These functionalities were collectively aimed at achieving three main objectives:

increasing sales of Coors products, having distributor and retailer staffs performing

much of the work autonomously, and building stronger relationships with the

distributors and retailers.

Now, consider a risk assessment that might have been performed by the risk

owner for this digitalized business platform. Table 8-5 summarizes this risk

assessment. Given this assessment, it would be reasonable to expect that a

digitalization risk management strategy put forward by the risk owner would involve:
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  Deterring and mitigating malicious intrusions, through the local business
platform, into Coors’ global digital platforms and business platforms.

 Ensuring that any future decision process to externalize any of the digital
platforms enabling the local business platform carefully examine the
providers’ capabilities to secure their platforms against malicious intrusions.

 Establishing a vigilance regarding the potential for competitors to introduce

retail shelf space innovations that could prove effective in taking market
share away from Coors’ products.

 Establishing a vigilance regarding the development of analytics technologies

and solutions aimed at the retail shelf space context.

Table 8-5
Risk Assessment for Coors’ POS Display Business Platform

Incident Expected
Threat Situational Assessment
Probability Losses
• Coors is a prominent firm selling a product (alcohol)
that could be considered controversial.
Malicious • Internet exposure & distributor/retailer Low (local)
High
Intrusion connectivity. High (global)
• Low loss exposure with the local business platform.
• High loss exposure with global platforms.
Natural • Favorable geographic location (Colorado front
Very Low Moderate
Disasters range).
Legal & • Limited access to financial systems.
Low Low
Regulatory • Limited privacy concerns.
New Digital • Analytics technologies.
Moderate High
Technology • Collaboration technologies.
Actions of a • Retail floor & shelf spaces are highly competitive
High High
Competitor commodities.
External • Business platform unlikely to be externalized.
Moderate Moderate
Sourcing • Digital platform likely to be externalized.
Inability to • Analytic capabilities focused on optimizing the use of
Moderate High
Respond retail store shelf space.

Digitalization Risk Management Practices

Digitalization risk management practices (i.e., policies, procedures and

programs) cover a very broad range of complex and ever-moving topics – topics for

which it is impossible to do justice in a few pages of text. To provide a glimpse of

what organizations are doing, this section describes a few of the current practices

regarding one threat area: that of malicious intrusions. This threat area was selected

for two reasons. First, since significant cyber-security breaches are reported on by
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news media on a regular basis today, most people are well aware of the topic.

Second, cyber-security breaches can result in huge financial losses, the size of which

is increasing annually. Data from 2010, for example, indicated that the average cost

of a security breach exceeded US $7 million.52

As a selection of the more common risk management practices for combating

malicious intrusions are described, note that a mix of technical and social mechanisms

are required. All too often, it seems, much more attention is given to the technical

practices, with the just-as-critical social practices being overlooked and/or

underfunded.

Securing Digital and Business Platforms Against Malicious Intrusions

It is impossible for any organization to fully protect itself against malicious

intrusions. That said, all organizations need to understand the intrusion risk

exposures of their digital and business platforms and take commiserate steps to both

harden these platforms and detect (and mitigate) any intrusions that occur.

Hardening a platform involves installation of hardware, software and

physical impediments that increase the effort required by a perpetrator, such that all

but the most determined perpetrators either bypass the platform (moving on to

easier targets) or are so hindered that they quickly give up. Detection involves

putting in place software and manual scanning processes that identify problematic

behaviors transpiring within digital platforms and business platforms.

52
R. Appan and D. Becic, “Impact of Information Technology (IT) Security Information
Sharing among Competing IT Firms on Firm’s Financial Performance: An Empirical
Investigation,” Communications of the Association of Information Systems, Vol. 39, 2016, pp.
214-241.

198
 Perhaps the most recognized hardening tactics involve the use of firewalls,

encryption technologies, access control mechanisms, and physical barriers to develop

multi-layered defensive shields around an organization’s digital and business

platforms. Less prominent is identity management software that seeks to identify

(“Who are you?”), authenticate (“Can you prove your identity?”) and authorize

(“What are you allowed to do?”) attempts, legitimate and illegitimate, to access

platforms and their contents. The most difficult of these questions is

authentication. As the technology improves and costs drop, authentication

methods are moving away from examining what you know (e.g., a password) to

examining something you have (e.g., biometrics such as the use of fingerprints, iris

scans, voice scans, etc.).

The most familiar detection tools are those directed at viruses (i.e., malicious

software code), that have eluded the barriers erected in hardening a platform. Less

visible are the huge investments organizations make in (1) capturing and then

analyzing the streams of digitalized transactions being executed on digital and

digitalized platforms, and (2) embedding processing logic into the software handling

these transactions to identify and reroute problematic transactional events.

Intra-Organizational Information Sharing Regarding Malicious Intrusions

As emphasized earlier, digitalization risk management is a participation sport

demanding the involvement of all employees. However, organizations’ employees

demonstrate wide variance in: their awareness of, knowledge of and sensitivity to

security breaches; their platform access privileges; their willingness to act in

compliance with security breach policies and procedures; and, their abilities to act

appropriately in the face of a security breach.

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 Because of these variances, many organizations are including comprehensive

intra-organizational information dissemination and sharing programs as prominent

components of their efforts to prevent and mitigate malicious intrusions. These

programs typically include:

 Awareness Training: All employees are made aware of the basics of cyber-
security risk management (both work-related and home-computer use) and,
specific to each employee, those risks most likely to arise as employees
carry out their day-to-day work activities.

 Platform Usage Training: Each employee interacting with a specific digital or

business platform is provided with the knowledge and skills to effectively
deal with the digitalization risks associated with that platform.

 Specialized Training: All technology professionals and all risk owners are
provided with advanced education to develop the capabilities needed for
them to carry out their assigned responsibilities.

 Technical Support: All employees are provided ready access to a cyber-

security support group that can answer questions that arise regarding the
risk of malicious intrusions and that can aid an employee when faced with a
probable or actual security breach.

Extra-Organizational Information Sharing about Malicious Intrusions

Organizations’ leadership teams are increasingly recognizing the value of the

external sharing of information about security breaches. Initially, most organizations

were reluctant to report on security breach incidents because of the expectation that

most stakeholders (e.g., consumers, value stream participants, strategic partners,

securities analysts, etc.) would react negatively, at least in the short-term. However,

200
the consequences of reported security breaches, while still negative, have been

declining over time.53,54 Three explanations for this decline are:

 More effective remediation and disaster recovery by firms, as well as a

decrease in customers refraining from doing business with firms that
experienced a security breach.

 The U.S. Government’s promotion, since 1999, of industry-based trade

associations known as information sharing and analysis centers (ISACs). As
of 2016, there are eighteen sector-based ISACs coordinated under a
National Council of ISACs.

 The enactment of federal and state security breach notification laws.

As more organizations actively gather and share information on digitalization-

risk threats, vulnerabilities and incidents, as well as best practices in digitalization

risk management, their capabilities to combat malicious intrusions will only improve.

Rather than feeling as if they are working alone against an increasingly hostile world,

organizations’ risk specialists and risk owners will increasingly find themselves

coordinating with and collaborating with their peers in other organizations, including

competitors, in order to drive informed decision making.

The Board of Directors and Digitalization Risk Management

As a general rule, those organizations most successful in applying digitalization

for competitive purposes have developed exceptional capabilities in digitalization risk

management. But, who, ultimately, is accountable for the quality of an organization’s

53
L. Gordon, M. Loeb and L. Zhou (2011), “The Impact of Information Security
Breaches: Has There Been a Downward Shift in Costs?”, Journal of Computer Security, Vol.
19, No. 1, 2011, pp. 33–56.
54
S. Goel and H.A. Shawky, "The Impact of Federal and State Notification Laws on
Security Breach Announcements," Communications of the Association for Information
Systems: Vol. 34, January 2014, pp. 37-50.
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digitalization risk management capabilities? With a public firm, it is the firm’s Board

of Directors.

However, most Boards of Directors have only gradually – and grudgingly –

stepped up to their oversight responsibilities regarding digitalization risk

management. For example, studies55,56,57 of Boards of Directors portray the following

practices:

 Board members are not actively recruited for their digitalization expertise.
Few executives of organizations recognized as digitalization leaders are
members of Boards of Directors.

 Very limited discussions of digitalization take place at Board meetings.

 When digitalization is discussed at Board meetings, these discussions tend to

be after-the-fact updates regarding recent, significant digitalization
initiatives.

 Most of this limited discussion of digitalization occurs in Board committee

meetings. Most often, this committee tends to be the audit committee,
where the issues raised are done so in reaction to a problematic event.

 Few Boards of Directors have a committee focused exclusively on

digitalization.

Overall, a state of complacency regarding digitalization continues, with Board

members believing that their organization’s leadership team has a solid handle on

managing the risks of digitalization. That said, a growing number of exceptions to

this general depiction can be observed in recent trends regarding Boards of Directors

and digitalization.

55 S. Huff, P. Maher and M. Munro, “Information Technology and the Boards of

Directors: Is there an IT Attention Deficit,” MISQ Executive, June 2006, pp. 55-68
56
M. Parent and B. Reich, “Governing Information Technology Risk,” California
Management Review, Spring 2009, pp. 134-152.
57
S. Andriole, “Boards of Directors and Technology Governance: The Surprising State
of the Practice,” Communications of the CAIS, Volume 24, Article 22, 2009, pp. 373-394.
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 What should be the role of Boards of Directors in managing digitalization risk?

Three Board responsibilities are most important. The Board of Directors must assure

that their organization is not overly exposed to digitalization risks that threaten

business continuity, regulatory compliance and competitive success. In order for

these responsibilities to be met, Boards of Directors need to adopt best practices such

as:58,59

 Bringing members with digitalization experience and expertise onto the

Board.

 Regularly inviting senior executives whose work responsibilities involve

strategically-critical digitalization initiatives to Board meetings.

 Systematically including digitalization issues on the agenda of full Board

meetings. For the most part, the focus of these discussions needs to
address strategic rather than tactical issues, including Board reviews of all
major digitalization-related assets, investments and initiatives.

 Establishing a Board digitalization committee.

Accounting for Digitalization Risks in Digital Strategy Formulation

Digitalization risks affect digital strategists’ thinking in two ways: by adding

layers of complexity onto their efforts to enhance existing business models and to

innovate with new business models, and by requiring that the requisite capabilities

are in place to enable both business model formulation and business model

implementation. Table 8-6 describes how each of the four elements of business

models are influenced.

M. Bloch, B. Brown and J. Sikes, “Elevating Technology on the Boardroom Agenda,

58

McKinsey Quarterly, 2013, No. 1, pp. 99-103.

59
H. Sarrazin and P. Willmott, “Adapting Your Board to the Digital Age,” McKinsey
Quarterly, 2016, No. 3, pp. 89-95.

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 Table 8-6
How Business Models Are Affected by Digitalization Risks

Value Propositions Profit Models

 Provide value in return for personal
data that is captured, archived
and/or used.
 Ensure the security, and hence the
trustworthiness, of digital platforms
and business platforms.
Core Capabilities
 Digitalization risk management
capabilities (accounting for all threat  Digital technologies.
areas).
 Comprehensively and accurately
account for the digitalization risk
management costs associated with
developing, implementing and
evolving a business model.
Dynamic Capabilities
Tuning of digital strategists’
environmental scanning regarding:
 Digitalization threats.
 Strategic capabilities.
 External sourcing providers.
 Competitors’ business model
innovations.

Increasingly, critical features of the value propositions being offered to pipeline

ecosystem consumers and network ecosystem participants are dependent on

personal data provided by or collected about individuals. If an individual feels the

quid pro quo is inadequate, the individual is unlikely to engage, partially or fully, in

market ecosystem interactions. Similarly, market ecosystem participants lacking

trust in the platforms enabling a value proposition would be expected to refrain from

platform interactions.

The long-term expectation from aggregating the profit models associated with

a business model is that the business model will prove profitable. However, if a

business model’s risk exposure requires extensive digitalization risk management

capabilities, and if the investment and operating costs associated with these

capabilities are not fully accounted for in the business model’s aggregated profit

models, then what might appear initially to be a very successful business model is

likely to become a huge liability over time.

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 If nothing else, this chapter’s content should have driven home the point that

in a world of pervasive digitalization, digitalization risk management has become a

core capability for all organizations and a strategic capability for some (e.g., financial

services organizations, e-commerce organizations, cloud-based organizations, etc.).

If digitalization knowledge and experience is not represented within organizations’

senior leadership teams, as well as within the Board of Directors of private firms,

then it becomes unlikely that a strong digitalization risk management capability will

be developed.

Finally, and most importantly, as extensive digitalization pervades an

organization’s strategies and operations, the breadth of the organization’s dynamic

capabilities must span an increasingly-wide gamut of markets, competitors, strategic

partners, strategic capabilities and digital technologies.

A Recap and Look Ahead

Competitive success in the face of digital disruption requires organizations’

leadership teams and digital strategists to demonstrate relentless vigilance with

regard to digitalization opportunities and, as covered in this chapter, digitalization

threats. But, how can such a mindset be established within an organization’s

members? In the next chapter, six actions aimed at just such an objective are

described.

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 Chapter 9. Executive Mandates: Digital Strategy

Today, leadership teams are likely to find themselves spending an

inordinate amount of time examining the opportunities and thr eats pervasive

digitalization poses to their organization, their industry, their employees and

themselves. The digitalization of pipeline ecosystems and network ecosystems, of

the products and services being exchanged within these ecosystems, and the core

capabilities driving competitive success continues at an incessant pace. Most

worrisome, perhaps, is a realization that it is increasingly difficult to predict the

source and direction of the next potentially-damaging move by a competitor.

Then, once a competitive attack has occurred, deciding how to respond

becomes just as perplexing. The options seem endless:

 Doing nothing at all, hoping that the attack will dissipate quickly with
minimal effect.

 Distracting your existing customers from the competitor’s move through

surface-level enhancements to the value propositions offered to these
customers.

 Boosting the effectiveness of your executing business model through a

series of digitalization initiatives.

 Quickly imitating the attack (as best as is possible given held-capabilities),

hoping to ride the wave, limit the damage and capture some of the new
value being created.

 Introducing a well-thought-out but small-scale disruption of your executing

business model in order to capture a niche in or to redefine your current
market space or to create a new market space.

 Aggressively reallocate resources from the digitally-threatened market space

to a digitally-promising one that matches well with your core capabilities.

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If anything, arriving at an effective competitive response can prove to be a greater

challenge than recognizing and understanding the implications of a threatening move

by a competitor.

So, how should organizations’ leadership teams position themselves and their

organizations for incessant digital disruption? The first step is to acknowledge that,

while digital technologies are the basis of digital disruption, digital technologies are

not the basis of effective digital strategy. Instead, what is critical is the adoption of

a digitalization mindset across the leadership team (and, ideally, all of an

organization’s members), the building of a digitalization culture across the

organization, and the infusion of key notions into the thought-processes of digital

strategists. The following six mandates are offered to senior executives desiring to

maintain their organizations’ competitiveness in the face of digital disruption:

 Embrace a Digitalized Ecosystem Mindset

 Innovate and Iterate for Digitalization Success

 Invest in Data and Analytics

 Evolve Processes and Platforms at Multiple Speeds

 Track and Valuate Intangible Digital Assets

 Cultivate a Digitalization Culture

Embrace a Digitalized Ecosystem Mindset

The dominant mindset held by many, if not most, senior executives today is

that their organizations operate in a well-defined competitive space, engage in

mostly-linear upstream and downstream processes, and execute a relatively-stable

business model. But, digitalization shakes up the competitive space in many ways:

incumbent competitors are reinventing themselves; new entrants (startups, digital

207
giants, technology entrepreneurs, etc.) regularly emerge; and, suppliers,

intermediaries and consumers are demonstrating increasing flexibility in deciding

with which organizations to interact and with which markets to participate, as each

seeks out the value propositions that best meet their ever-evolving desires and

requirements.

Successful leadership teams today are increasingly adopting a digitalized

ecosystem mindset – that is, a view of competitive spaces as markets characterized

by high rates of business model evolution/innovation, high levels of information

sharing and value co-creation by market participants, and high rates of participant

entry/exit. In such competitive environments, competitive success largely hinges on

leadership teams: looking outward first, and then inward; and, developing

capabilities to identify, assess, engage, collaborate with and disassociate from

strategic partners.

The primary intent driving the digitalized ecosystem mindset is to become the

partner of choice in each market space in which an organization participates. What

makes an organization an attractive partner in the face of digital disruption? A

deceptively short list of desired qualities includes:

 Capable, creative digital strategists (often referred to as chief digital

officers) across an organization’s operating and staff units, able to
orchestrate (internally and externally) innovative, value-adding digitalization
initiatives.

 A talented, digitally-savvy workforce.

 Efficient, secure, adaptable and interconnected platforms that can be

connected to or decoupled from quickly and with little investment.

Two organizations whose leadership teams are noted for having demonstrated

digitalized ecosystem mindsets are General Electric (GE) and LEGO.

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 Recognizing that it needed to transform itself into a modern digital business,

GE has invested over $1 billion to position itself to become a competitive leader of

the emerging, highly-digitalized market ecosystems within which it was already and

would be participating.60 To infuse a digitalized ecosystem mindset into the firm’s

executive leadership, GE consolidated each business unit under a chief digital

officer (CDO), with these CDOs reporting to the business unit CEOs. Importantly,

these CDOs have approval authority for digitalization-related investments. GE has

also gone on an ambitious hiring spree, bringing in thousands of new software

engineers, user-experience experts, and data scientists to acquire needed skillsets

and embed the right innovation mind-set.

After having verged on defaulting on its debt in the early 2000s, LEGO has

again become a thriving business once its leadership team adopted a digitalized

ecosystem mindset in which there was no longer a separate digital strategy that was

aligned with business strategy, but rather a corporate business strategy executed

through digitalization.61 The three core elements of LEGO’s overarching digitalized

business strategy involved: product innovation and the product ecosystem; digital

marketing; and, a transition toward global, rather than local, platforms. Key

initiatives put in place to enable this overarching strategy included: distributing much

of the corporate information technology function into business units; appointing CDOs

60
T. Catlin, L. Harrison, C.L. Plotkin and J.r Stanley, “How B2B Digital Leaders Drive
Five Times More Revenue Growth than Their Peers,” McKinsey Quarterly, October 2016,
http://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/how-b2b-
digital-leaders-drive-five-times-more-revenue-growth-than-their-peers
61
O.A. El Sawy, P. Kraemmergaard, H. Amsinck and A.L. Vinther., “How LEGO Built
the Foundations and Enterprise Capabilities for Digital Leadership,” MIS Quarterly Executive,
June 2016, pp. 53-64.

209
within business units for the purpose of orchestrating digitalized innovation;

nurturing an experiment, learn and iterate capability across the firm, leveraging the

complementary digitalization capabilities of LEGO’s ecosystem partners;

implementing flexible and open engagement platforms, while reducing complexity and

maintaining security in enterprise platforms; and, hiring flexible, dynamic and adaptable

employees able to cope with task and position changes and to work on digitalization

projects anywhere in the firm.

Innovate and Iterate

LEGO’s tactic of innovation via iteration is not uncommon among digitalization

leaders. Being a first-mover (or, an early adopter) with a new digital technology or

a new digitally-enabled functionality is fraught with risk. Will the technology work as

expected, and at what cost? Will enhancements to customers’ or employees’

interactive experiences be favorably received and, hence, contribute to improving the

value propositions of executing business models or lead to the creation of new

business models? Will the operational improvements made possible by new

functionality improve the profit models of executing business models or enable an

executing model to be applied to an adjacent market space? Iteration – that is,

engaging in a series of mindful strategic experiments – allows the proponents of an

innovation to gain some of the innovation’s anticipated benefits while still learning

about and improving the innovation.

Amazon, for example, uses an internal experimental platform to evaluate

improvements to its websites and products through a factual, experimental approach

210
to constant innovation.62 If anything, the number of these experiments is increasing

over time – as can be observed from an April 2014 letter to Amazon shareholders

that reported the number of these experiments growing from 546 in 2011 to 1,092

in 2012 to 1,976 in 2013.

Successful digitalization requires that organizations transform how they think

about innovation in two key ways. First, digitally-savvy talent must be deeply

involved with innovative initiatives at every stage: creating the idea, improving the

concept, building early prototypes, assessing the viability of these prototypes,

designing and launching a series of strategic experiments, and, finally, incorporating

the innovation as a standard way of doing business. Second, at their start, successful

digitally-enabled innovations are almost always kept separate from the standard way

of doing business. By separating innovative initiatives from normal operations, two

things occur: it becomes easier to attract creative, digitally-savvy talent to work on

the initiatives, and the innovative initiatives are less likely to be impeded by

entrenched ways-of-thinking, policies and procedures.

At some point, leadership teams need to make a critical decision: “Is a

successful digital innovation maintained as a separate entity or is it folded into the

standard way of doing business?” The ultimate goal for any established organization

is to develop capabilities that competitors are unable or unwilling to imitate.

Consequently, most leadership teams will want to eventually integrate the digital

innovation with the rest of the organization. Doing so creates a seamless digital-

physical experience, enables greater efficiency via economies of scale and scope,

62
P. Bell, “Sustaining an Analytics Advantage,” Sloan Management Review, Spring
2015, pp. 21-23.
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permits better coordination, avoids duplicated effort, and facilitates timely

communications and decisions. But, what if an organization’s established business

models are severely threatened by a digital innovation? In such situations, it just

might be best to keep separate the innovative business models and the established

business models, letting these compete for market share until only one is left.

Invest in Data and Analytics

Increasingly, the most telling pathway to value creation through digitalization

involves applying analytic models to the vast quantities of data permeating digitalized

market ecosystems. To take advantage of this pathway, an organization must

possess the capabilities to recognize the value potential of data streams that are both

fleeting and voluminous, and to capture, organize, analyze and apply these data in

value-creating ways. Thus, investing smartly and proactively in the technologies,

tools and talent needed to position an organization such that it is able to quickly and

effectively exploit data-related, value-creating opportunities as they arise can pay

huge dividends over time.

What exactly are these value-creating opportunities? Invariably, the

immediate answer to this question involves being able to combine data and analytic

models by using:

 Transactional data along with efficiency and effectiveness metrics to improve

operational process (upstream, internal, downstream) performance and
managerial process (decisions, coordination, oversight) performance.

 Customer/client, community, product, service and promotional data along

with market, industry and macroeconomic data to better understand
customer/client/community motivations and behaviors, product/service
portfolios, and market and business model viabilities.

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Less obvious, however, are data monetization opportunities. Data monetization

refers to the bundling together of well-defined sets of data and analytic models such

that the intangible value of data is transformed into something of tangible value. Two

primary approaches to data monetization exist.

With the first approach, streams of data involved in an organization’s

operations are captured, cleaned and repackaged (via analytics) such that the data

become valuable to other organizations. Think of the vast amounts of data a big box

retailer collects on POS devices, which can be complemented by associated

customer/geographic data. Or, think about the vast amounts of data collected by

auto insurance companies on the devices installed by car owners to monitor driving

behavior. Or, consider that one oil rig with 30,000 sensors may examine only one

percent of the data collected because it uses these data to detect and control

anomalies63 – ignoring the value of the data in supporting drilling optimization and

oil/gas prediction activities, when combined with similar data from hundreds of other

rigs. Such data products can be sold directly to organizations desiring to use the

data or to third-party data marketplaces.

With the second approach, an organization offering specialized services to

clients can use historical client-engagement data to develop optimized algorithms

that can then be applied to data collected on a new client engagement, enabling

superior services to be provided to this new client at a price-point below that of many,

if not most, competitors.

63
J. Deichmann, K. Heineke, T. Reinbacher and D. Wee, “Creating a Successful
Internet of Things Data Marketplace, McKinsey Quarterly, October 2016,
http://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/creating-a-
successful-internet-of-things-data-marketplace
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 Consider, for example, ExcelShore, a digitalized tool developed by Cybage, an

Indian technology services provider.64 Initially conceived as tool for analyzing

Cybage’s internal resources, ExcelShore analyzes collected client data (e.g., the

client’s business history, current operations, prospective projects and resources; data

about the client’s industry; etc.) to generate solution recommendations for the client,

as well as a customized dashboard used by ExcelShore staff to manage the client

engagement. With ExcelShore, Cybage is able to offer fee structures (to its clients)

that are generally 20-25 percent lower than the fee structures offered by its larger-

scaled competitors – without compromising service quality or consistency.

For another example, consider the strategy followed by Littler, a global

employment and labor law practice, in unbundling many of the tasks involved in

delivering services to clients by assigning these tasks either to knowledgeable people

(possibly contractors) with pay scales below those of specialized attorneys or to

digitalized products with automation and analytics capabilities, depending on the level

of sophistication involved.65 Now, instead of billing clients for the hours its attorneys

spend on claims, Littler uses a fixed-fee pricing model based on productivity (per

grievance or complaint) for certain of its legal services. This change has resulted in

lower legal costs for clients (figures ranging from 10-35 percent), enabling Littler to

win new business.

64
A. Kathuria and B. Yen, “The Art of Winning an Unfair Game: Cybage & India’s IT
Industry,” Communications of the Association for Information Systems, Vol. 37, 2016, pp.
753-766.
65
M. Sawhney, “Putting Products into Services,” Harvard Business Review, September
2016, pp. 83-89.
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Evolve Processes and Platforms at Multiple Speeds

Organizations embarking on a digitalization journey almost always face a

recurring challenge – projects targeted at enhancing digitalized products, services,

engagement platforms and customer/community-facing processes tend to be more

numerous and to move at a much faster pace than projects aimed at enhancing the

mission-critical and house-keeping transactional processes and platforms that keep

an organization running and compliant with regulators. This in itself is not a problem.

What is a problem is that sooner or later – actually, mostly sooner – the process or

platform that evolves at a fast pace must be interconnected to and synchronized with

processes or platforms that evolve at a slower pace; and, it is with these efforts

aimed at interconnection and synchronization that serious problems can arise:

 Fast-paced projects are slowed down or derailed.

 Processes or platforms that must be quick, efficient, reliable and secure

begin to exhibit performance problems.

 Governance systems put in place to ensure process/platform stability

impede process/platform agility (or vice versa).

What can an organizations’ leadership teams do to minimize such problems?

Actually, the challenge is more severe than might be inferred from the above

discussion. All organizations today depend on digitalized processes executed from a

mélange of digital platforms and business platforms. Depending on the nature of the

processes hosted on a platform, a platform’s design could:

 Emphasize stability, agility or both.

 Emphasize operational excellence, customer intimacy and/or product

leadership.

 Evolve at a rate to maintain alignment with the rate at which crucial

ecosystem elements change; this could be a fast rate, a slow rate, or

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 anywhere in between.

Think of a juggler having to keep a set of balls moving despite the fact that each ball

is also moving in a unique orbit around a central orbital point. So, ideally, these

processes and platforms are not evolving at two rates of speed or at three rates of

speed, but at many rates of speed. Process owners and platform owners across the

organization must evolve their processes/platforms at very different rates of speed

and, over time, are likely to have to adjust these rates of speed.

So, again, what can an organization’s leadership team do? An easy, quick,

one-size-fits-all solution just does not exist. Instead, a leadership team needs to

fashion, over time, a new and consistent set of organization, platform and governance

models:

 Organization Design: establishing process and platform management

reporting structures to enable seamless process/platform design,
development, operation and evolution.

 Platform Design: transitioning to modular platform architectures, a

consistency in module interfaces, and an understanding of when and where
to use tight or loose inter-platform and intra-platform connections.

 Governance Design: redesigning an organization’s expansive collection of

planning, control and budgeting systems to facilitate, rather than inhibit, an
appropriate rate of evolution for each process and platform.

While organizations’ leadership teams may not possess the expertise involved in

carrying out these activities, it is critical that leadership teams provide direction and

oversight. Issues related to reporting structures, to platform architecture and to

negotiations regarding priorities, investment funds and operating budgets are

precisely those that can produce severe intra- and inter-unit conflicts – conflicts that

often can only be resolved by an organization’s most senior executives.

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Track and Evaluate Intangible Digital Assets

Two forms of capital underlay organizations’ digitalization success. The first

involves tangible digital assets, or the commodity technologies (e.g., servers,

routers, messaging services, Internet standards and software, etc.) that serve as the

building blocks of digital platforms and of business platforms. Invariably,

organizations’ investments in tangible digital capital appear as capital investment on

company books.

The second type of capital involves intangible digital assets, such as:

 Market, product, services and platform designs that attract, engage and
retain large numbers of ecosystem participants.

 Operational and analytical processes that capture, organize and exploit data
regarding market events, about operational and managerial activities, and
about participant beliefs, expectations, behaviors and perspectives.

 Knowledge and skills held by an organization’s employees as well as its

partners’ employees.

 Digitalization reputation acquired by an organization.

Well-known examples of intangible digital assets are Amazon’s and Netflix’s

recommendation engines, both of which have contributed significantly to each

company’s revenue growth and served as long-lived competitive barriers.

Conventional accounting invariably treats intangible digital capital as an expense,

rather than as a capital investment, thus creating an investment disincentive (at least

in the short-term).

With little guidance from conventional accounting methods regarding how to

track and attach financial value to intangible digital assets, many organizations’

financial groups perform this task poorly or not at all. As a consequence, an

organizations’ leadership teams have little solid evidence on which to assess their

217
organizations’ investment in digitalization over time or to compare these investments

against that of competitors. Both a retailer lacking rich data on consumers or a bank

unable to control the capture of customer data (because customers access banking

services through a third-party digital platform) face increasingly daunting competitive

disadvantages. Organizations’ leadership teams must ensure that their organizations

have taken on the difficult tasks of:

 Reclassifying expenditures to separate out intangible digital assets.

 Tracking the spending on intangible digital assets (typically overlooked by

accounting procedures).

 Assigning appropriate value to investment in intangible digital assets.

 Treating these investments, minimally with regard to digital strategy

formulation, as capital investments rather than current expenses.

Cultivate a Digitalization Culture

Acquiring and developing technology-based capabilities – such as those based

on Big Data, Big Data analytics and cloud services – are obviously crucial to

digitalization success. However, consider the issues presented as mandates for

executive action: mindsets, innovation, experimentation, data monetization,

operating at multiple and variable speeds, and a preoccupation with intangible assets.

Each of these, at their core, reflect aspects of a digitalization organization culture.

Organization culture is one of those terms that are intuitively understood but

that prove difficult to define simply. Suffice it to say that an organization culture

is comprised of the assumptions, values and norms of behavior collectively held by

an organization’s members. Spend time observing how an organization’s members

act and interact, and you will inevitably come away with an understanding of the

organization’s culture. The more time spent observing, the richer the understanding.

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This same thing happens as new employees sense and adopt the particular culture

of their organization and act accordingly.

In stable environments, executives tend to rely on what has been learned from

past experiences to build the system of policies, directives, rules, routines and top-

down reporting relationships that mold employees’ perspectives and actions. In

volatile environments, however, organization structures that protect and exploit

current mindsets and capabilities often induce strategic inertia, where attention and

investment is given to things that no longer matter. As has been recurrently

emphasized, environments beset with the constant threat of digital disruption are

anything but stable. As the drivers of this instability are strongest at the edges of

organizations and at the edges of market-focused ecosystems, the importance of

local knowledge and strategic agility intensifies. As a result, executives striving to

position their organization for digitalization success are advised to transition their

organizations and themselves toward a very different organization culture, a

digitalization culture that largely relies on the capabilities and judgments of

employees – working alone and in small groups – holding local knowledge and

unencumbered by bureaucratic or overly-burdensome hierarchical constraints.

What does this emerging digitalization culture look like? A good starting

point is to recognize how digitalization is enabling us, as we carry out our consumer

and employee roles, to achieve better outcomes from taken-actions:66 we are being

given more options, more information about these options, and more permission to

act as we think best. To grasp what is implied by – and gained from – a culture that

66
B. Libert, M. Beck and J. Wind, The Network Imperative: How to Survive and Grow
in the Age of Digital Business Models, Boston, MA: Harvard Business Review Press, 2016.
219
first and foremost relies on employees’ capabilities and judgement, consider the

following two illustrations.67

 An Asian insurance company hosted an intensive digitalized jam session over

a 48-hour period, assigning 120 participants to ten cross-functional teams
and tasking these teams, via a friendly competition, to redesign how
customers processed their healthcare claims. The final outcome produced
went far beyond the initiative’s original scope – effectively eliminating the
need for processing customers’ claims.

 A telecom company wanted to both shorten its product-development time

(six months, on average, from start to active-trial) and include employee
training and internal pilots within this shortened time period. A mixed team
of product managers, digital technology professionals and engagement-
experience experts tore apart the company’s old process and laid out a
simpler, automated approach that allowed customers of its fiber, mobile,
and TV services to access service in three quick steps. They conceived,
tested, and built the new process in less than twelve weeks.

Rather than attempting to define the elements that come together to form a

digitalization culture, we illustrate a digitalization culture in practice through the

efforts taken by Valve Corporation’s leadership team to transform the firm’s

organization culture.68

Beginning as a video game company, Valve has evolved into a digital

distribution platform, known for products such as Steam and SourceForge. Valve’s

self-reported revenues per employee and profit per employee metrics exceed those

of Facebook and Google, signaling quite vividly that Valve is succeeding in a fast-

67
T. Catlin, L. Harrison, C.L. Plotkin and J. Stanley, “How B2B Digital Leaders Drive
Five Times More Revenue Growth Than Their Peers, McKinsey Quarterly, October 2016.
http://www.mckinsey.com/business-functions/marketing-and-sales/our-insights/how-b2b-
digital-leaders-drive-five-times-more-revenue-growth-than-their-peers
68
The discussion of the Valve Corporation has been adapted from materials in: T. Felin
and T.C Powell, “Designing Organizations for Dynamic Capabilities,” California Management
Review, Summer 2016, pp.78-96.
220
moving environment requiring constant agility, strategic innovation, and market

adaptation.

A key factor behind this success is Valve’s culture, which emphasizes the firm’s

dependence on employees’ capabilities and judgements (as reflected in the Valve

new employee handbook). Employees are expected to:

 Steer, without asking for approval, the firm toward opportunities and away
from risks.

 Constantly be looking for more valuable ways to spend their time.

 Allocate up to 100% of their time to self-directed projects.

Why such a dependence on the initiative of individual employees? In environments

demanding that competitive opportunities and threats are quickly sensed and

responded to, the immediate challenge for organizations’ leadership teams is to

effectively leverage the information, knowledge and capabilities held by the

organizations’ members and applying these in collective decision-making. Thus, a

paramount task of the leadership teams of organizations seeking digitalization

success is to ensure:

 Employees are in constant contact with relevant elements of the competitive

environment and with other individuals (both inside and outside the
organization) holding relevant information, knowledge and capabilities.

 Employees are provided the motivation, time and resources to learn from,
share with, and collaborate with these other individuals.

Valve’s leadership team has gone beyond traditional decentralization toward radical

decentralization by giving talented specialists in product research, design and

engineering full autonomy to propose projects, recruit project teams, establish

budgets, set timelines, and ship products to customers.

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 Nonetheless, it is important to recognize that radical decentralization has

advantages and disadvantages. As a guiding principle, radical decentralization gives

authority to those who operate closest to the action – that is, to individuals, groups

and units holding specialized knowledge and operating at an organization’s edges,

thereby facilitating local creativity and experimentation while minimizing bureaucratic

roadblocks. What radical decentralization lacks is the assurance that taken-decisions

and taken-actions are vetted by affected-others (individuals, groups and units) and,

if needed, adjusted. Allowing for such assurance, however, takes time. In an era of

digital disruption, it does not take much of a delay to significantly reduce the benefits

actually realized from a competitive action.

To address this quandary, Valve employs mechanisms referred to as social

proofs – a social influence mechanism aimed at producing coordinated behavior

among individuals. As Valve’s leadership team sees it, a purposeful system of social

proofs provides an effective counterweight to the chaotic tendencies of radical

decentralization.

The primary behavioral mechanism driving Valve’s social proofs is self-

selection; that is, employees vote with their feet. They assess markets for new

opportunities, gather information about existing projects and teams, and decide by

themselves whether to join an existing team or to form a new project. Obviously,

not all the decisions made by employees are optimal, for the employee or for Valve.

However, experience at Valve suggests that, in the aggregate, the choices made by

talented, empowered individuals provide insightful, reliable and low-cost predictions

of where and how fast the market is moving.

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 While self-selection empowers the right people to make decisions, it does not

by itself overcome the disadvantages of radical decentralization. Not wanting to

impair employees’ initiative by putting in place multiple approval layers, Valve’s

leadership team conceived a method of social convergence referred to as the rule of

three. Learning from experience, Valve’s leadership team recognized that it was a

rare occurrence for one or two individuals, regardless of reputation or capability, to

command enough information or resources to sense, shape and seize a sizeable

market opportunity. Under the rule of three, new projects are only considered for

approval when at least three individuals come together to propose a project. The

rule of three, thus, provides a light-touch intervention that allows Valve to stimulate

innovation and to limit the chaos that can otherwise debilitate radical

decentralization.

A Recap

It is important to recognize that the six mandates just described are neither

silver bullets nor readily implemented. The policies and practices put in place in one

organization may or may not work when applied within another organization.

Instead, in approaching each of the mandates, an organization’s leadership team

needs to interpret the mandate through a lens that reflects the organization’s in-

place culture, human talent, digitalization history and competitive environment. Such

an assessment should suggest how the spirit of the mandate is best applied as well

as the steps to be taken to implement the refashioned mandate.

As an organization’s leadership team begins to achieve progress in diffusing

these six mandates across their organization, a number of things should begin to

occur, including:

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  Existing policies and practices will increasingly be questioned.

 Employees will increase the amount of time they spend interacting with
others outside their areas of immediate responsibility.

 Decisions will increasingly be expected to be justified through facts, e.g.,

analyzed data.

 The volume of innovative ideas bubbling up across the organization should

increase.

While a surge in such behaviors might be unnerving to some of an organization’s

managers and executives (at least in the near term), it is precisely these type of

behaviors that will enable an organization’s digital strategists to engage in the

dialogues and debates that ultimately generate timely and successful digital

strategies.

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 GLOSSARY

CHAPTER 1: Digital Innovation and Disruption

Analytical domain – one of the three domains of digitalization; organizational

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

Architecture – an overarching design framework specified to maintain established

policies and to enable component interoperability.

Automation – one of the four engines of digitalization; simplifying and digitizing

complex tasks and task-sequences, eliminating unneeded tasks and, as appropriate,
performing tasks via digital technologies rather than via humans.

Blended organization – an organization that operates, to varying extents, as both

a pipeline organization and a network organization.

Business-to-business (B2B) – when market exchanges occur between two

organizations.

Business-to-consumer (B2C) – when market exchanges occur between an

organization and a person.

Business disruptions – when an industry’s incumbents face one or more

challengers whose business models offer far greater value to customers than the
incumbents’ business models and these incumbents are unable to effectively respond
to the ensuing competitive threat.

Business model – a simplified and aggregated conceptualization of the value-

creating, profitability-sustaining activities of an organization.

Collaborative domain – one of the three domains of digitalization; organizational

activities involved in enabling digital technologies, humans and organizational entities
to share data, information and/or knowledge in making decisions and in getting
things done.

Consumer-to-consumer (C2C) – when market exchanges occur between two

people.

Control – one of the four engines of digitalization; embedding rules within digital
solutions to identify out-of-control events/situations, such that out-of-control
events/situations do not occur or, if they do occur, are quickly corrected.

Data – attributes of objects or events represented in digital (discrete sets of ones

and zeroes) form.

537
Digital disruption – when the innovative uses of digital technologies and
globalization are the primary factors leading to incumbents within existing industries
facing overwhelming competitive challenges and to entirely new industries being
created.

Digital giants – firms that have mastered digitalization and are able to harness their
business models and digitalization expertise to disrupt a wide range of industries.

Digital technologies – the technologies (involving hardware, software and, most

often, sophisticated combinations of hardware and software) involved in specifying,
capturing, processing, storing and transmitting data.

Digitalization – applying digitization within organizations and within the social and
economic contexts within which organizations are embedded.

Digitization – the purely technical processes associated with converting sensed and
captured data into binary form, storing and transmitting these binary data,
manipulating these data, and storing/transmitting the outcomes of these data
manipulations.

Domains of digitalization – the three fundamental spheres of organization activity

within which digitalization occurs: operational, analytical and collaborative.

Early-adopters – organizations whose leadership teams are regularly among the

first to apply new forms of digitalization.

Efficient market – a market that provides maximal opportunities to producers and

consumers to effect transactions with minimal transaction costs.

Empowerment – one of the four engines of digitalization; providing humans facing

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

Engines of digitalization – the four fundamental mechanisms through which digital

technologies effect changes within organizations and their broader social/economic
contexts: automation, control, empowerment and interaction.

Firm – one of the two primary mechanisms (along with the market) for organizing
economic activities; economic exchanges in a firm mainly occur through hierarchical
structures and control structures. Also referred to as an organization.

Globalization – the ongoing process of interaction and integration among the

people, companies and governments of different nations.

Incumbents – firms having operated in an industry for a long time and holding well-
established business models, organization structures and resource control structures.

538
Interaction – one of the four engines of digitalization; enabling entities (human or
digital) to engage in timely, meaningful dialogues with one another (overcoming
barriers of space and time).

Interoperability – when two or more digital solutions are able to seamlessly

exchange data and able to apply these exchanged data.

Linear value stream – sequence of value-adding steps within a pipeline ecosystem

in which raw materials are assembled into components and then into finished value-
units that are delivered to consumers, either through a complex downstream process
facilitated by intermediaries or through a simpler, direct-to-consumer downstream
process.

Market – one of the two primary mechanisms (along with the firm) for organizing
economic activities; economic exchanges in a market mainly occur through pricing
mechanisms and contractual mechanisms.

Moore’s law – a characteristic of digital technologies, whereby their capability per

dollar essentially doubles each year.

Network ecosystem – a market-focused ecosystem in which a network of value-

unit producers and a network of value-unit consumers are brought together by a
network orchestrator.

Network orchestrator – creates and manages the market environment and the
transaction environment within which value-unit exchanges occur within a network
ecosystem.

Organization – one of the two primary mechanisms (along with the market) for
organizing economic activities; economic exchanges in an organization mainly occur
through hierarchical structures and control structures. Also referred to as a firm.

Open – a technology that is available for use (and modification) by anyone, though
some form of payment may be required to gain access to the technology.

Operational domain – one of the three domains of digitalization; organizational

activities involved in getting things done.

Pipeline ecosystem – a market-focused ecosystem in which a producer

organization targets a collection of value-units at one or more consumer segments
and fashions a linear value stream involving numerous upstream, midstream and
downstream organizations to deliver the value-units to consumers.

Proprietary – a technology that is tightly controlled by its developer.

Technology entrepreneurs – firms (often young and small) that bring specialized
digitalization expertise to innovate, transform or disrupt certain aspects of an
industry’s value stream or value-units.

539
Value-unit – the entities (information, a good or a service) being exchanged within
a market-focused ecosystem.

Vertically-integrated – when a producer in a pipeline ecosystem performs many,

if not most, of the activities involved with upstream and downstream linear value
stream processes.

CHAPTER 2: Digital Strategy Fundamentals

Adaptive agility – the ability of a firm to aggressively introduce incremental

enhancements into currently-executing business models.

Agility – the ability of a firm, first, to detect potentially disruptive threats and
opportunities and, then, to marshal the resources and managerial insights required
to subdue threats and/or exploit opportunities.

Business model – a simplified and aggregated conceptualization of the value-

creating, profitability-sustaining activities of an organization.

Collision at the core – directing managerial attention and resources toward building
relationships with digitalization leaders in order to understand and recognize business
model innovations aimed at reinventing currently-executing business models.

Core capabilities – an element of a business model that describes the tangible and
intangible resources needed to successfully implement a business model’s value
proposition and profit model.

Cost model – describes the nature of the costs borne in producing revenue streams
from an executing business model and how these costs will be controlled to provide
requisite levels of profitability.

Customer intimacy – a value discipline by which organizations tailor and shape

products and services to fit increasingly segmented consumer needs and wants.

Dynamic capabilities – an element of a business model that describes the

intangible resources needed to (1) sense and assess opportunities for business model
enhancement, replication and innovation, and (2) successfully implement these
enhancements, replications and innovations.

Dynamism – the ability of a firm to innovate, transform and disrupt by

demonstrating strategic adaptability, speed and entrepreneurism.

Entrepreneurial agility – the ability of a firm to aggressively introduce radical

enhancements into currently-executing business models or to introduce new business
models.

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Experimentation at the edge – directing managerial attention and resources
toward understanding and recognizing business model innovations within adjacent
industries and within emerging industries.

Operational excellence – the value discipline by which organizations provide

consumers with very reliable products and/or services at very competitive prices
delivered with minimum difficulty or inconvenience for consumers.

Product leadership – a value discipline by which organizations produce a

continuous stream of new, innovative and stylish products/services.

Profit model – an element of a business model that defines how an organization

expects to be profitable; consists of revenue models and cost models.

Reinvention at the root – directing managerial attention and resources toward

understanding and recognizing the necessity to cannibalize existing core capabilities
and dynamic capabilities by investing significantly in digitization and digitalization
capabilities.

Revenue model – an element of a profit model that describes where, when and how
sustainable revenue streams will materialize when executing a business model.

Stability – the ability of a firm to withstand disruptions by maintaining operational

reliability and efficiency.

Strategic experiment – a small-scale, tightly-contained competitive move taken to

learn about a potential digital innovation or potential digital disruption.

Strategic intent – a statement of competitive direction and purpose that directs

digital strategists’ thought processes.

Value disciplines – three sets of activities that are crucial in differentiating an

organization from its competitors; an organization’s dominant value discipline
strongly influences its executing business models.

Value proposition – an element of a business model that defines how an

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

CHAPTER 3: Digitalized Business Models for Pipeline Ecosystems

Big Data – high-volume streams of digitized data that are captured and organized
for use.

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Big Data analytics – applying statistical and mathematical models to organized
collections of Big Data.

Data/document standards – policies and rules that allow data and documents to
be accessed and used by value stream participants.

Disintermediation – an intermediary is bypassed, thus shortening and narrowing a

value stream.

Economies of scale – the advantages that arise with increased volume of output.

Economies of scope – the advantages that arise when a family of related goods are
produced rather than a single good.

Electronic Data Interchange (EDI) – an Era 1 form of industry-based sets of

data/document standards.

Intermediary – an organization whose capabilities are used to reach suppliers or

end consumers.

Intermediary transformation – an existing intermediary vertically integrates, thus

becoming a producer.

Intermediation – choosing to reach suppliers or end consumers through another

organization.

Long-tail phenomenon – the ability of digital markets to offer a far broader variety
of value-units than could be offered in comparable physical markets.

Make-versus-buy decision – a firm (or individual) decides between making an item

or performing an activity itself (themselves) or having another firm (or individual)
make the item or perform the activity.

Pervasive connectivity – when smart devices across an ecosystem are

interconnected, thus creating opportunities for anywhere, anytime interaction.

Platform – assemblage of digital technologies that hosts digital and digitally-enabled

resources.

Primary processes – work activities directly involved in delivering value-units to

customers.

Production costs – direct costs to produce an activity or perform an activity.

Reintermediation – a new intermediary is added to a value steam, thus lengthening

and broadening the value stream.

Self-regulation – an organization captures data associated with critical market-

related transactions, monitors this data for problems, reacts responsively and

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responsibly if and when problems arise, and keeps regulators and value-stream
participants aware of these activities.

Smart device – an assembled piece of digital technology containing the digital

capability to sense, analyze and act on environmental signals.

Social media complements – the opportunities made available to value-unit

consumers to engage with the value-unit’s producer and/or retailer and with other
consumers via social media.

Stock holding – building up various kinds of inventories, thus providing buffers that
soften the effects of poor demand forecasts.

Support processes – work activities that provide direction, resources and oversight
for primary processes.

Transaction costs – additional costs involved (beyond production costs) when an

item or activity is acquired from someone else.

Value stream platform – a platform, hosting digitized data and documents as well
as digitalized managerial and operational processes, that can be accessed and used
by a value stream’s participants.

Vertical integration – when a producer in a pipeline ecosystem performs many, if

not most, of the activities involved with upstream and downstream linear value
stream processes.

World Wide Web (WWW) – an Era 2 one-to-many connectivity mechanism

enabling organizations (and individuals) to access and use content stored across the
Internet.

CHAPTER 4. Digital Strategy Formulation for Pipeline Organizations

Barriers to competitive retaliation – tactics taken to prevent competitors from

eroding an organization’s gained competitive advantages.

Business model enhancement – incremental changes are made to one or more of

the four elements of business models.

Business model innovation – radical changes are made to one or more of the four
elements of business models or a novel configuration of these elements is fashioned.

Business model replication – a business model proven successful in one market is

applied within an adjacent market.

Business platform – a platform hosting digitalized operational and managerial

processes.
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Channel multiplicity – ensuring that a sufficient mix of interconnection channels
are available to handle the data, messages and documents flowing to and from
individuals and digital solutions so that a preferred channel is available for use.

Complementary resources barrier – based on requirements for unique or rare

non-digital resources in establishing a digitalized competitive advantage.

Customer switching costs – the costs borne by a consumer choosing to move to a

competing product/service.

Data mart – an archive of organized data focused on a specific sphere of work.

Data warehouse – a single, comprehensive archive of organized data.

Digital platform – a platform hosting technology services.

Digital resources barrier – based on an organization’s investment in unique or rare

digital/digitalized assets and capabilities.

Event visibility - making key events (as well as key non-events) known to the
individuals and the digital solutions taking action so that actions can be taken.

Global – a digital solution designed and built to be used by most of an organization’s

work units.

Local – a digital solution designed and built to be used by one or only a few of an
organization’s work units.

Loose-coupling – neither of the interconnected platforms needs to be modified in

order that the data, messages and/or documents being exchanged are consistently
interpreted across both platforms.

Mission statement – answers the question: “What must we do to achieve our

strategic vision?”.

Modularity – each of a platform’s major functionalities, or modules, operates

independent of other functionalities and obtains needed information or resources
from a common coordinating module.

Preemption barrier – based on an organization’s investments that limit

competitors’ opportunities and incentives to undertake retaliatory action.

Pricing mechanism – the means by which a value-stream participant captures its

share of the value being created by the value stream.

Project management capabilities barrier – based on an organization’s

investment in needed project management capabilities.

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Strategic vision – answers the question: “What kind of organization do we wish to
become?”.

Tight-coupling – one or both of the interconnected platforms need to be modified

so that the data, messages and/or documents being exchanged are consistently
interpreted across both platforms.

Well-architected platform – exhibits an appropriate balance in (1) the stability and

agility of the hosted functionality, and (2) the costs of building, enhancing and
extending platforms across functional, unit and organization boundaries.

CHAPTER 5. Digital Strategy and the External Sourcing of Capabilities

Cloud computing – provisioning a pool of digital assets and digitally-enabled

services such that these services can, on demand, be accessed and applied by clients
via the Internet.

Collaboration-based crowdsourcing – the crowdsourcing community collectively

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

Commodity capabilities – the capabilities that are required or are otherwise

beneficial for an organization to operate, that do not contribute to competitive
positions (aside from their absence), and that are readily available from external
sources.

Crowdsourcing – externalizing a capability to a community of individual agents.

Externalization of a capability – transferring ownership and decision rights

regarding a capability, the assets used in executing the capability, and/or the
management of the capability from inside an organization’s boundary to outside this
boundary.

Loose-governance – increased discretion is given to the provider with the increased

risk exposure managed through the client-provider relationship and by regularly
assessing whether or not an engagement continues to prove beneficial for both the
client and the provider.

Multisourcing – contracting with multiple providers rather than a single provider.

Offshore – the external provider of a capability is located in a different country than

is the client.

Onshore – the external provider of a capability is located in the same country as is

the client.

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Outsourcing a capability – transferring ownership and decision rights regarding a
capability, the assets used in executing the capability, and/or the management of the
capability from inside an organization’s boundary to outside this boundary.

Peripheral core capabilities – the capabilities that are necessary for an

organization to gain and maintain its competitive positions, but that are not a source
of competitive advantage.

Prediction market – targets broad, diverse communities to predict events or

outcomes.

Social information – information formed through exposure to the contributions of

other community members and these members’ expressed confidence in their
contributions.

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

competitive advantage.

Tight-governance – characterized by a constant, detailed and deep visibility into

how a work activity is being carried out and the extent to which a comprehensive set
of negotiated obligations is being met.

Tournament-based crowdsourcing – the crowdsourcing community (working

individually or in teams) submits finalized, independent task solutions; the
crowdsourcer/client then selects one of these contributed solutions, or perhaps a few
solutions, in exchange for financial or non-financial compensation.

CHAPTER 6. Digitalized Business Models for Network Ecosystems

Blended organization – an organization that operates, to varying extents, as both

a pipeline organization and a network organization.

Complement – an entity that increases the perceived worth of a value-unit.

Core transaction – the primary market exchange activity driving both producers
and consumers to an ecosystem’s market platform.

Critical mass – the point at which the number of product/service-adopters results

in the product/service becoming dominant within its market space.

Cross-side effect – existence of positive (or negative) effects felt by a community

associated with a network ecosystem as the number of members increases with
another of the ecosystem’s communities.

Crowd-based capitalism – a two-sided market that brings together two crowds, or

communities, of individuals: one community possessing an under-used asset or skill

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(the value-unit) and the other possessing a short-term need for such an asset or
skill.

Market platform – the organized collection of digital and business platforms that
hosts the content and functionalities that establish, operate and govern the
ecosystem’s market.

Money-side – a revenue-generating community associated with a network

ecosystem.

Multi-sided market – a network ecosystem with more than two actively

participating communities.

Network effects – where the worth of or demand for a value-unit grows as an

exponential function of the number of current consumers of a value-unit and/or the
number of complements available to these consumers.

Network externality – where the worth of or demand for a value-unit grows as an

exponential function of the number of current consumers of a value-unit and/or the
number of complements available to these consumers.

Same-side effect – existence of positive (or negative) effects within a community

associated with a network ecosystem.

Subsidy-side – an incentivized community associated with a network ecosystem.

The sharing economy – an economy driven by crowd-based capitalism.

Two-sided market – a network ecosystem in which a producer community and a

consumer community are brought together to engage in value-unit exchanges.

Winner-take-all-market – a market where the potential exists that a critical mass

of consumers will adopt one producer’s products/services.

CHAPTER 7. Digital Strategy Formulation for Network Organizations

Ancillary transactions – transactions associated with a network organization’s

value propositions that bring communities other than producers and consumers to
the platform.

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

Market design – a network organization’s competitive moves aimed at enhancing

the efficiency of its constituted market.

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Market platform design – a network organization’s competitive moves aimed at
building market platform content/functionality in order to enhance community
participants’ satisfaction with offered value propositions.

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

Market thickness – ensuring sufficiently large numbers of producers and consumers

such that a strong likelihood exists that satisfactory producer-consumer matching will
occur.

Side-switching – existing producers become consumers and/or existing consumers

become producers.

Spillover – when a taken action targeted at one purpose affects other purposes.

CHAPTER 8. Grappling with the Risks of Digitalization

Authentication – techniques aimed at proving a person’s or a digital entity’s

identity.

Business platform operations – the execution of an organization’s digitalized

operational and managerial processes that are hosted on business platforms (and on
market platforms).

Cybercriminal – uses hacking techniques and tools in order to take illegal actions
for financial gain or to take over digital assets in order to launch a series of illegal
actions.

Data privacy – concerns that arise wherever personally-identifiable or other

sensitive information is captured, collected, stored and used.

Detection – putting in place software and manual scanning processes that identify
problematic behaviors transpiring within digital platforms and business platforms.

Digital assets – digital technologies (hardware and software), digitized data, and
digitization/digitalization capabilities applied in configuring digital platforms and
business platforms.

Digitalization risk – the likely occurrence of digitalization-related incidents that

have the potential to negatively impact an organization’s operational performance
and/or competitive position.

Financial loss – theft; fraud; extortion; destruction of uninsured facilities,

equipment and materials; drops in stock valuations; regulatory fines; legal fees, court
awards and out-of-court settlements; etc.
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Graceful degradation – operations affected by a natural disaster do not
immediately shut down, but instead gradually slow down, allowing time for affected
operations to be shifted to other physical locations prior to a complete shutdown.

Hactavist – uses hacking techniques and tools for the purpose of bringing attention
to a social or political issue.

Hardening a platform – installation of hardware, software and physical

impediments that increase the effort required by a perpetrator such that all but the
most determined perpetrators either bypass the platform (moving on to easier
targets) or are so hindered that they quickly give up.

Intellectual property loss – theft of digitized ideas, innovations and other forms
of creative expression (e.g., trade secrets; blueprints; digitalized processes;
proprietary digital content; the underpinnings of strategies and business models;
etc.).

Internal controls – the processing logic and rules embedded within digitalized
financial reporting systems to ensure the correct handling of financial transactions
and the accuracy of produced financial reports.

Legal and regulatory requirements – digitalization-related statutory policies and

rules requiring protective actions, most often aimed at preventing harm to others.

Malicious intrusion – a perpetrator’s success in getting through an organization’s

security-related defenses.

Natural disaster – tornadoes, hurricanes, earthquakes, tsunamis, nuclear

emergencies, collapsed dams, broken gas or water pipes, etc.

Ongoing risk control – monitoring a risk area such that the incident occurrences
are detected and resolved before excessive losses occur.

Reputation loss – depreciation of an organization’s image or of its brands that

undermines the trust and goodwill held by participants in the various market-focused
ecosystems with which the organization participates.

Revenue loss – short-falls in revenue streams or lost revenue streams traced to

operational disruptions, reputation loss, the inability to respond effectively to
competitors’ actions, etc.

Risk assessment – estimating the risk exposure associated with a risk area.

Risk assumption – accepting that losses are likely to arise if and when an incident
occurs in a risk area, covering these losses through internal funds and third-party
insurance.

Risk deterrence – taking action to reduce the likelihood that an incident will occur
in a risk area.
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Risk exposure – the probability of a risk occurring multiplied by the expected loss
to be borne if the risk occurs.

Risk management – creating awareness and a common understanding across an

organization’s members about the existence and nature of a risk domain; and, putting
in place risk management policies, procedures and programs to ensure that critical
risks in the domain are appropriately addressed by the appropriate individuals.

Risk mitigation – tempering (as much as possible) the consequences of a risk

incident by taking corrective actions.

Risk planning – establishes the contexts within which risk management activities
are carried out.

Terrorist – uses hacking techniques and tools for the purpose of causing harm and
havoc within an established geo-political order.

CHAPTER 9. Executive Mandates: Digital Strategy

Chief digital officer (CDO) – senior executive/manager having approval authority

for digitalization-related investments.

Data monetization – bundling together well-defined sets of data and analytic

models such that the intangible value of data is transformed into something of
tangible value.

Digitalization culture – an organization culture where competitive success largely

relies on the capabilities and judgements of employees – working alone and in small
groups – holding local knowledge and unencumbered by bureaucratic or overly-
burdensome hierarchical constraints.

Digitalized ecosystem mindset – a view of competitive spaces as markets

characterized by high rates of business model evolution/innovation, high levels of
information sharing and value co-creation by market participants, and high rates of
participant entry/exit.

Intangible digital assets – market, product, services and platform designs that
attract, engage and retain large numbers of ecosystem participants; operational and
analytical processes that capture, organize and exploit data regarding market events,
about operational and managerial activities, and about participant beliefs,
expectations, behaviors and perspectives; knowledge and skills held by an
organization’s employees as well as its partners’ employees; digitalization reputation
acquired by an organization; etc.

Organization culture – the assumptions, values and norms of behavior collectively

held by an organization’s members.

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Social proof – a social influence mechanism aimed at producing coordinated
behavior among individuals.

Tangible digital assets – the commodity technologies (e.g., servers, routers,

messaging services, Internet standards and software, etc.) that serve as the building
blocks of digital platforms and of business platforms.

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