Insight

The idea was introduced in the 1990s by James Moore as a new concept in strategic planning. It has since taken on a life of its own, largely driven by the early adoption of technology firms.

What makes the idea profound is that it suggests a new way of organizing economic activity—other than the construct of a firm and an industry. It represents an imperative to think completely differently about strategy.

Why business ecosystems matter?

Their importance has increased dramatically over the last few years, leaving many asking: why now?

Many talk about the impact of digital, which certainly plays a role. But digital is enabling and accelerating the shift, not causing it. The deeper reason has less to do with technology and more to do with economy.

The nature of the firm and, as a result, its structure and that of the industry, is to minimize transaction costs. The term “transactions” encompasses a wide range of activities needed to source, produce, distribute and sell goods and services, together with the administration and coordination required to undertake them efficiently.

When doing so becomes expensive and cumbersome, it makes more sense to conduct these activities within the firm — concentrating resources, owning the means of production, standardising processes, establishing value and supply chains, and developing the competencies needed to do the work as efficiently as possible.

Looking back, it is easy to see why organizing into firms has long been the most sensible thing to do.

It’s expensive to produce and distribute complex products at scale. It’s hard to orchestrate all of this activity efficiently, especially when the expertise needed to do so is rare.

Looking ahead, it’s clear this is no longer the case. Transaction costs for a surprising range of activities are dropping fast. This is where advances in digital technologies play an undeniable role.

Digital as the catalyst for change

Digitization turns atoms into bits. It standardizes units of information that are no longer excludable or in competition but do have a marginal cost of near zero.

More powerful and ubiquitous computing acts on this information with exponentially growing capability and autonomy. Connectivity drives further standardization and deeper interoperability.

Increasing communication enables more complex coordination and transactions. As Marc Andreesen put it, "software is eating the world.”

The result? What was once complex, hard and rare is becoming simple, easy and abundant. Firms no longer need to consolidate resources, own the means of production or lock up scarce expertise in long-term employment contracts. These things can now be accessed, acquired and coordinated within the business ecosystem.

Uber can sell rides while owning neither cars nor drivers. Airbnb can rent rooms without owning hotels or the staff needed to maintain them.

This is testimony to how much digital advances have lowered transaction costs.

Business ecosystems are about strategic choice

Whether a business sets itself up as a vertically-integrated firm or distributed network and whether it owns things or rents them is, once again, a choice.

Importantly, it’s a strategic choice, not just a technological one.

Though discussions about ecosystems may start within digital tribes, they should be advanced by the C-suite. The consequences of choosing to own versus access a service will have a profound impact on long-term profitable growth and competitive advantage, not just the cost of operations.

It will also become a more urgent choice, confronting more and more business executives. The pace of digital adoption is accelerating, not slowing down.

Over time, it’s inevitable that transaction costs will continue to drop. ² This makes it increasingly possible to assemble amazing capabilities on an as-needed basis and reconstitute the shape of the organization as circumstance demands.

Optimizing the enterprise will become a dynamic and ongoing effort, not something that happens once in a market cycle. Perhaps most importantly, it’s a choice that most leaders and firms need to analyze very carefully as making the right choice will have serious long-lasting business implications.

Overcoming the challenges ahead

The management discipline of deciding which activities to own versus those to access is complex and depends on far more than just cost. It’s a heady mix of distinguishing the levers that can be used to create value, enable competitive advantage or accelerate market velocity, among other factors.

These factors are not static. They change depending on how players in the ecosystem evolve, how often and how new players enter. This discipline is far from common practice, it’s only just starting to take shape even for competent ecosystem players.

Another challenge is that most executives aren’t likely to approach these choices rationally. They are, quite understandably, biased by two established practices: