Opening Up the Boundaries of the Firm

For decades, received wisdom has been that the optimal way to organize production is via the firm, internalizing upstream and downstream functions and expanding around the world

Published: Jul 3, 2010 12:02:40 AM IST
Updated: Jul 2, 2010 04:43:52 PM IST
Opening Up the Boundaries of the Firm

Many executives have been eagerly awaiting the return of better business conditions. But in doing so, they may have overlooked a significant source of growth and productivity that is emerging right now: new economic models that are redefining the relationships between firms and consumers.

New economic models, underpinned by an array of technologies, are emerging in which traditional relationships between firms and their consumers are being simultaneously dismantled and redefined. In these new models, individuals are becoming involved in the production and innovation process; they are sharing information and opinions about products and services; and they are combining in different ways to create content in peer-to-peer markets.

At first glance this seems to run counter to our understanding of how markets function. Traditional explanations such as Ronald Coase’s Theory of the Firm emphasized the central role of the firm in production, owing to its efficiency in keeping transaction costs low. Later theories pointed to the benefits of economies of scale and scope. For decades, received wisdom has been that the optimal way to organize production is via the firm, internalizing upstream and downstream functions and expanding around the world.

The firm is and will remain the central entity for production in markets; but firms are now part of a more complex ecosystem of productive activity made possible by an array of information technologies, such as cloud computing, advances in mobile technologies, social computing, remote sensors and advanced analytics. In this ‘ecosystem’, the relationship between firms and consumers has changed, leading to new forms of interaction and the ability to create economic value in six new ways.

1.    Co-production is allowing companies to harness the ideas, tastes and productive powers of customers and individuals across the world. Danish toy maker Lego has launched an online customization platform where its customers can assemble lists of components for their own designs, which are then made available to other customers.

Marketocracy, an investment-management and research firm, crowd sources its mutual fund investment strategy from more than 100,000 model portfolios run by amateur investors. These models of co-production and open innovation offer businesses a two-way gain: the potential to drive R&D productivity levels up while increasing consumer utility by allowing consumers to have greater input in the design and production phases.

2.    New bridges between producers and customers are enabling businesses to access markets in places where geographic or economic distance had previously kept supply and demand apart. Zain, a mobile telecom company based in Kuwait, has partnered with Citibank to offer mobile phone banking services in rural parts of East Africa. New intermediaries are also emerging to facilitate the productive activities of others: InnoCentive, the innovation platform, is one such example (see sidebar). Information technologies are also allowing businesses to cater to a wider variety of tastes and needs – for example, in the sale of music or books – helping them serve the “long tail” of niche markets.

3.    New forms of business-to-business commerce are becoming technologically possible as changes in the capability, reach and cost of IT allow the aggregation of small pockets of demand for business services that were previously uneconomic to serve. Li & Fung, previously a trading company, now offers other companies sophisticated procurement services. Amazon, known for its online retail presence, now provides others with data warehousing and application platform services. Technologies are therefore creating an environment of heightened specialization for B2B commerce. This presents a range of opportunities, particularly for small companies, which can now take advantage of the benefits of scale previously enjoyed only by large businesses.

4.    Consumer-to-consumer content is being unleashed as groups of like-minded individuals use IT to share information about products and services. Historically, it was very time-consuming and expensive for consumers to compare products: information was expensive, difficult to reproduce and often proprietary. In response, large firms created strong brands to signal product quality and utility. However, technologies have changed this, and now, information is increasingly a non-excludable, non-rivalrous (i.e., public) good. On TripAdvisor’s website, for instance, people can discuss the experiences they have had in different restaurants and hotels, shifting the balance of power from the hospitality sector to the traveller. In this way, consumer-to-consumer content has reduced comparison costs and empowered the ‘virtual crowd’ – since it is now a key indicator of consumer utility.

5.    Peer-to-peer markets of cooperative production are now arising from the instantaneous interactions of millions of individuals. Groups of like-minded people can now ‘cluster’ together online – at scale – giving them greater control over the way a good or service is produced and effectively mitigating the market power of established firms. At the same time, networks are allowing individuals to provide each other with services, creating the potential to reduce transactions costs associated with service delivery., a marketplace where individuals lend money to other individuals, creates an alternative to banks for borrowers and a new form of investment for individual lenders.

6.    Cooperative consumption is coming back into vogue, underpinned by new technologies. Historically, consumer cooperatives existed to enhance the bargaining power of the consumer vis-à-vis the firm. Today, with the emergence of social computing and the maturation of mobile communications technologies, individuals can easily signal their buying intentions to other consumers online – in real-time. Shanghai-based, a group-buying service that sells everything from paint to ceiling lamps, had 1.6 million members within five years of its launch. This is but one example of how technologies are reducing barriers to collective action among consumers by allowing greater ease of communication and enhancing the ability to rapidly enlarge a group of committed customers. This is, in turn, altering the dynamics of discounting and product tailoring.

The changes we have described are blurring the boundaries of the firm. Businesses will have to operate in a much more open and complex ecosystem, with customers, suppliers, competitors and other producers increasingly interdependent and interconnected. As technology unwrites today’s rules of commerce, companies will need to work out how to navigate through the added complexity and capture their share of the vastly greater economic upside.

Orchestrating Across the Ecosystem

How to respond? In this new environment, success will depend on how businesses orchestrate value across the new ecosystem. Companies’ success will now depend on a rugged defence of their core business coupled with an intrepid quest to attract, aggregate and harness the power of other ecosystem players that offer comparative advantage. Following are three actions that can help businesses do just that:

1.    Identify and defend your competitive essence
This new era will require businesses to radically rethink their value chain and their place in it. The first thing executives must do is identify the competitive essence of their business. This is not necessarily the same as what a company may regard as its core. Indeed, in this new era, it is likely that a company’s essence in the eyes of the consumer (and, in time, the canny investor) may not be what originally differentiated it. For example, a manufacturing company may find that its competitive essence revolves increasingly around the services it provides, rather than its original core products. Since the emergence of portable media players and smartphones, consumers have downloaded billions of songs, videos and free and paid apps. Many companies will continue to produce electronic hardware goods, but the nucleus of their value proposition to customers may in future increasingly lie in their value as platforms for media content, apps and games – rather than from the products themselves. Similarly, concepts of pricing may come to be inverted, with people increasingly willing to pay a premium for things that used to be free (or comparatively cheap) while expecting companies to give away things they used to charge for – as witness the evolving economics of ‘news vs. analysis’ in journalism, or ‘recorded vs. live’ in the music industry.

2.    Throw open the doors

Success in the new era depends on a business’s ability to marshal value from others across the wider network. That is, companies are only as strong as the communities and networks they create for themselves. People are willing to create services (e.g. iPhone apps), test software (e.g. through Nokia beta labs) or offer their research skills (e.g. via Procter & Gamble’s open innovation website). ‘Cloud computing’ is also creating opportunities for companies to open up and access standardized business services – such as data warehousing or application platforms – on offer from other businesses. Companies are also increasingly reaching out to communities of customers through social computing platforms. For example,, a social network operated by Starbucks, lets the company’s consumers share, discuss and vote on ideas that can improve its performance. Opening the borders of the firm in these ways may go against the grain for many businesses, since it encompasses making information, especially company data, available externally. However, it will allow firms to tap into wider networks of value, helping them take advantage of the new forms of economic activity that are now emerging.

3.    Harvest insight from the ecosystem
In the new era, information is both cheap and ubiquitous – but getting real business insight is harder than ever. Companies must be good not just at harvesting data from the wider ecosystem but also at drawing on analytics technologies to sort out the signals from the noise. Online DVD rental company Netflix, for instance, uses algorithms to predict the movies its customers will be interested in viewing by analyzing their online recommendation history. The vast majority of information being created outside of the firm is unorganized; and few firms mine the data created by their own activities. But in the emerging ecosystem, companies will need either to grow the capabilities to develop insight from the sea of data available to them, or pay others to do it for them. Good data analysis can help businesses understand their external environment – such as their global communities of consumers – as well as better manage internal performance.

As economic value migrates across this wider ecosystem, firms that heed this advice will be well-positioned to optimize performance and develop new business models that harvest value outside the boundaries of the firm.

Mark Purdy is chief economist at the Accenture Institute for High Performance, where Matthew Robinson leads the global trends research program and Katharine Hirst is a senior researcher.

Examples of orchestrating across the ecosystem
There are a number of companies who exemplify characteristics of successful orchestration:

•    Nokia operates an open innovation model in which it uses external talent to drive the delivery of new products and services – making abundant use of social computing to source new ideas. Its “Beta Labs” website plays host to hundreds of thousands of testers who provide feedback on new and potential Nokia apps, while the “Nokia Pilots” program lets users communicate their ideas about product and service improvement. “Forum Nokia” – a portal available in English, Chinese and Japanese – gives outside developers access to resources to help them design, test, certify, market and sell their own apps, content, services or websites via Nokia mobile devices. Also, company wikis post the progress of its current projects.

•    Li & Fung is a B2B company that uses online platforms, remote sensors and advances in mobile communications to manage the supply chains of other businesses. Previously a trading company, Li & Fung now provides sophisticated procurement services to other businesses, including some of the world's biggest retailers. Since the company does not own the factories it operates, it relocates production sites to benefit from the cheapest locations. Li & Fung is a one-stop shop in the B2B space – using technologies to design, manufacture, source and transport clothing, furniture, toys, beauty products, sporting goods – and  more.

•    InnoCentive creates a marketplace where companies post problems they need solved, and scientists, engineers, inventors, business people and research organizations compete to come up with the best solutions. Working with partners such as the Chinese and Russian national science academies, InnoCentive has recruited what it calls a “solver” base of more than 200,000 of the world’s brightest minds, who can receive up to US$1 million for delivering solutions. It is a hub for innovation, much as is a hub for jobs and eBay for products. The “seeker” companies have included Eli Lilly, P&G, Dow Chemical, BASF, and Syngenta – each paying fees of up to US$100,000 annually to post challenges.

•    Kiva is a not-for-profit organization that connects entrepreneurs from developing countries with people who want to lend money to them. Launched in 2005, it is the first person-to-person micro-lending website, empowering individuals to lend directly to entrepreneurs across the globe. Like a social networking site, Kiva posts profiles of potential borrowers; lenders then peruse the profiles and make loans to people whom they find appealing. As of November 2009, Kiva had brought together 573,000 lenders with 239,000 entrepreneurs – helping deliver some US$100,000 in microloans right across the world.


Click here to see Forbes India's comprehensive coverage on the Covid-19 situation and its impact on life, business and the economy‚Äč

[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]

Show More
Post Your Comment
Required, will not be published
All comments are moderated
Making Enterprise Systems Work
Why Did The Crisis Happen? One Does Not Need To Look Too Far Back