MGT411 Innovative and Creative Business Thinking University of Phoenix Material Organizational Ecosystem Case Study Wal-Mart Stores, Inc. is a leading company in its industry and a widely recognized name, both domestically and internationally. Additionally, Wal-Mart has taken steps to ensure the success of not only its company but also their business ecosystem. Wal-Mart Stores, established in 1969, is the largest retail company in the world, with over 4,000 stores in 12 countries. Wal-Mart has three types of retail stores: discount stores, supercenters, and neighborhood markets, as well as Sam's Club warehouse stores. Between the various types of Wal-Mart and Sam's Club stores, Wal-Mart Stores, Inc. offers merchandise and services that range for grocery goods and household supplies to tire and lube service, clothing, and vision centers. Additionally, Wal-Mart has an online music store, a private label cosmetics brand, and pre-paid debit cards for low-income US customers. Some of the company's private-label brands are Sam's Choice, Equate, No Boundaries, Mainstays, and Parent's Choice. Wal-Mart also stocks several licensed brands, including General Electric, Disney, McDonalds, and Mary-Kate and Ashley. For the fiscal year ending in January 2008, Wal-Mart reported over $375 billion in revenue (Wal-Mart Stores, Inc. Company Profile, 2008). Wal-Mart has dominated its market, in part, due to the way it approached its business ecosystem (Iansiti & Levien, 2004). There are many examples of Wal-Mart's ecosystem approach, including their procurement system and their recent focus on more specialized stores. Keeping its ecosystem in mind, Wal-Mart has built a procurement system that not only enhances its performance, but the performance and operation of businesses within its ecosystem. Wal-Mart Stores, Inc. requires that all of its suppliers operate the RetailLink system (Requirements, 2008). RetailLink is a one-of-a-kind system that allows suppliers to receive real-time data regarding their product in individual stores. Such real-time data allows suppliers to effectively plan for and execute distribution, while also personalizing their product supply by store. According to Iansiti & Levien (2004), \"Wal-Mart's procurement system offers it's suppliers invalueable real-time information on customer demand and preferences, while providing the retailer with a significant cost advantage over its competitiors\" (p. 69). Stankevich (2002) noted the success of Wal-Mart's system in terms of micromarketing and efficiency. Jon Ragsdale, vice president of marketing at Dickies, discussed with Stankevich the way RetailLink brought to light the differences in demand for different sizes and colors of products in different markets. Ragsdale noted, \"Before RetailLink, we were using pretty much a cookie cutter approach to stores\" (para. 10). In recent years, Wal-Mart has begun to take a more specialized approach by offering different goods and adjusting the layout of the stores based on location demographics. Once a one shop fits all store, Wal-Mart now has several stores that cater to the needs of a specific location. One store in Plano, TX has been adapted to appeal to the higher number of affluent customers in that area. The store now offers consumer-electronic specialists, that are more versed in the specifics of electronics than a typical sales associate. Also, that particular store adapted the sporting goods section to have more of a child focus, based on the notion that more affluent individuals purchase their sporting goods from country clubs (Zimmerman, 2006). In terms of competition, Wal-Mart plays an interesting role. While the most obvious conclusion is that Wal-Mart is the biggest competition for small businesses and retailers, it is apparent that their approach to a business ecosystem is also positive for small business owners. \"For small manufacturers and small consumer-goods companies, Wal-Mart is the customer they pray for and Page 1 mgt411r1 MGT411 Innovative and Creative Business Thinking the one that can propel their company into big-time sales. Wal-Mart is the 'elephant' they dream of bagging\" (Campbell, 2005, para. 5). Questions After reading the case study on Wal-Mart, use the case study and information from your weekly readings to answer the following questions in 200 to 300 words each. 1. What is a business ecosystem? Do all businesses function within an ecosystem? Why or why not? 2. What potential role does the ecosystem play in Wal-Mart's innovation efforts? Provide examples. 3. In terms of innovation and creativity, what are the advantages and disadvantages of functioning within an ecosystem? Page 2 mgt411r1 MGT411 Innovative and Creative Business Thinking References Campbell, A. (September 19, 2005). On Wal-Mart, small businesses and business ecosystems. Small Business Trends. Retrieved June 13, 2008 from http://www.smallbiztrends.com/2005/09/on-wal-mart-small-businesses-and.html/ Iansiti, M. and Levien, R. (March 2004). Strategy as ecology. Harvard Business Review. 82(3). 68-78. Retrieved on June 13, 2008 from Ebscohost database. Requirements. (2008). Wal-Mart. Retrieved on June 16, 2008 from http://walmartstores.com/Suppliers/248.aspx Stankevich, D. (March 1, 2002). Sizing the market: Wal-Mart masters the micromarketing of clothing. Velocity Company. Retrieved on June 16, 2008 from http://www.velocity.biz/company/pr_sizing_walmart_retaillink.htm Wal-Mart Stores, Inc. Company Profile. (May 2008). Datamonitor Business Information Center. Retrieved on May 30 from Marketline Business Information Center. Zimmerman, A. (2006, September 7). Thinking local: To boost sales, Wal-Mart drops onesize-fits-all approach. The Wall Street Journal. p. A1. Retrieved on June 13, 2008 from ProQuest database. Page 3 mgt411r1 Predators and Prey: A New Ecology of Competition by James F. Moore Harvard Business Review Reprint 93309 HarvardBusinessReview MAY-JUNE 1993 Reprint Number JAMES F. MOORE PREDATORS AND PREY: A NEW ECOLOGY OF COMPETITION 93309 J.B. FULLER, J. O'CONOR, R. RAWLINSON TAILORED LOGISTICS: THE NEXT ADVANTAGE 93305 ROBERT EISNER SENSE AND NONSENSE ABOUT BUDGET DEFICITS 93303 T GEORGE HARRIS THE POST-CAPITALIST EXECUTIVE: AN INTERVIEW WITH PETER F. DRUCKER 93302 MAHLON APGAR, IV UNCOVERING YOUR HIDDEN OCCUPANCY COSTS 93301 MARCO IANSITI REAL-WORLD R&D: JUMPING THE PRODUCT GENERATION GAP 93307 J. J. GABARRO, J.P. KOTTER HBR CLASSIC: MANAGING YOUR BOSS 93306 DANIEL NIVEN HBR CASE STUDY WHEN TIMES GET TOUGH, WHAT HAPPENS TO TQM? 93310 ANDREW STARK IN QUESTION WHAT'S THE MATTER WITH BUSINESS ETHICS? 93311 KEVIN R. McDONALD WORLD VIEW WHY PRIVATIZATION IS NOT ENOUGH 93308 TIMOTHY W. FIRNSTAHL FIRST PERSON THE CENTER-CUT SOLUTION 93304 Predators and Prey: A New Ecology of Competition by James F. Moore For most companies today, the only truly sustainable advantage comes from out-innovating the competition. Successful businesses are those that evolve rapidly and effectively. Yet innovative businesses can't evolve in a vacuum. They must attract resources of all sorts, drawing in capital, partners, suppliers, and customers to create cooperative networks. Much has been written about such networks, under the rubric of strategic alliances, virtual organizations, and the like. But these frameworks provide little systematic assistance for managers who seek to understand the underlying strategic logic of change. Even fewer of these theories help executives anticipate the managerial challenges of nurturing the complex business communities that bring innovations to market. How is it that a company can create an entirely new business community - like IBM in personal computers - and then lose control and profitability in that same business? Is there a stable structure of community leadership that matches fast-changing conditions? And how can companies develop leadership that successfully adapts to continual waves of innovation and change? These questions remain unanswered because most managers still frame the DRAWING BY TRAIAN FILIP problem in the old way: companies go head-to-head in an industry, battling for market share. But events of the last decade, particularly in high-technology businesses, amply illustrate the limits of that understanding. In essence, executives must develop new ideas and tools for strategizing, tools for making tough choices when it comes to innovations, business alliances, and leadership of customers and suppliers. Anthropologist Gregory Bateson's definition of coevolution in both natural and social systems provides a useful starting place. In his book Mind and Nature, Bateson describes co-evolution as a process in which interdependent species evolve in an endless reciprocal cycle - in which \"changes in species A set the stage for the natural selection of changes in species B\" - and vice versa. Consider predators and their prey, for instance, or flowering plants and their pollinators. James F. Moore is president of GeoPartners Research Inc., a management consulting firm in Cambridge, Massachusetts that specializes in issues of business strategy and implementation. Copyright 1993 by the President and Fellows of Harvard College. All rights reserved. ECOLOGY OF COMPETITION Another insight comes from biologist Stephen to maintain leadership, or incorporating new innoJay Gould, who has observed that natural ecosysvations to fend off obsolescence, executives must tems sometimes collapse when environmental understand the stages that all business ecosystems conditions change too radically. Dominant combipass through - and, more important, how to direct nations of species may lose their leadership. New the changes. ecosystems then establish themselves, often with previously marginal plants and animals at the cenbusiness ecosystem, like its biological ter. For current businesses dealing with the chalcounterpart, gradually moves from a ranlenges of innovation, there are clear parallels and dom collection of elements to a more strucprofound implications. tured community. Think of a prairie grassland that To extend a systematic approach to strategy, I is succeeded by stands of conifers, which in turn suggest that a company be viewed not as a member evolve into a more complex forest dominated by of a single industry but as hardwoods. Business ecopart of a business ecosyssystems condense out of the tem that crosses a variety of original swirl of capital, cusindustries. In a business tomer interest, and talent ecosystem, companies cogenerated by a new innoevolve capabilities around vation, just as successful a new innovation: they species spring from the natwork cooperatively and ural resources of sunlight, Bet on a seed innovation that can competitively to support water, and soil nutrients. lead to revolutionary products. new products, satisfy cusEvery business ecosystem Discover the right customer value tomer needs, and eventually develops in four distinct incorporate the next round stages: birth, expansion, proposition. of innovations. leadership, and self-renewDesign a business that can serve For example, Apple Comal - or, if not self-renewal, the potential market. puter is the leader of an death. In reality, of course, ecosystem that crosses at the evolutionar y stages blur, and the managerial least four major industries: challenges of one stage often personal computers, concrop up in another. Yet I've sumer electronics, informaobserved the four stages in many companies over tion, and communications. The Apple ecosystem time, across businesses as diverse as retailing, encompasses an extended web of suppliers that inentertainment, and pharmaceuticals. What recludes Motorola and Sony and a large number of mains the same from business to business is the customers in various market segments. process of co-evolution: the complex interplay Apple, IBM, Ford, Wal-Mart, and Merck have all between competitive and cooperative business been or still are the leaders of business ecosystems. strategies (see the table, \"The Evolutionary Stages While the center may shift over time, the role of the of a Business Ecosystem\"). leader is valued by the rest of the community. Such During Stage 1 of a business ecosystem, enleadership enables all ecosystem members to invest trepreneurs focus on defining what customers toward a shared future in which they anticipate want, that is, the value of a proposed new product profiting together. or service and the best form for delivering it. VictoYet in any larger business environment, several ry at the birth stage, in the short term, often goes to ecosystems may vie for survival and dominance: those who best define and implement this custhe IBM and Apple ecosystems in personal computtomer value proposition. Moreover, during Stage 1 ers, for example, or Wal-Mart and Kmart in disof a business ecosystem, it often pays to cooperate. count retailing. In fact, it's competition among From the leader's standpoint, in particular, busibusiness ecosystems, not individual companies, ness partners help fill out the full package of value that's largely fueling today's industrial transformafor customers. And by attracting important \"foltion. Managers can't afford to ignore the birth of lower\" companies, leaders may stop them from new ecosystems or the competition among those helping other emerging ecosystems. that already exist. The rise of the personal computer is a revealing Whether that means investing in the right new example of ecological business development. In the technology, signing on suppliers to expand a growearly 1970s, a new technology - the microprocesing business, developing crucial elements of value A The Birth of Business Ecosystems 76 HARVARD BUSINESS REVIEW May-June 1993 sor - emerged with the potential to spawn vast new applications and dramatically reduce the cost of computing. Yet this innovation sat dormant for several years. By 1975, hobbyist machines like the Altair and IMSAI had penetrated a narrow market. But these computers were not products that could be used by the average person. Starting in the late 1970s, Tandy Corporation, Apple, and others introduced early versions of what would eventually become the personal computer. The seed innovation they all chose was the microprocessor, but these first designers also recognized that other products and services had to be created to bring the whole package together. These ranged from hardware components to software to services like distribution and customer support. Apple and Tandy each had a different strategy for creating a full, rich ecosystem. Apple worked with business partners and talked about \"evangelizing\" to encourage co-evolution. While the company tightly controlled its basic computer design and operating system software, it encouraged independent software developers to write programs for its machine. Apple also cooperated with independent magazines, computer stores, and training institutions - and even seeded a number of school districts with Apple IIs. Tandy, on the other hand, took a more vertically integrated approach. It attempted to buy and then own its software, ranging from the operating system to programming languages and applications like word processors. The company controlled sales, service, support and training, and market de- velopment by selling exclusively through its Radio Shack stores. At the same time, it discouraged independent magazines devoted to its TRS-80 machines. Therefore, Tandy's simpler and more tightly controlled ecosystem did not build the excitement, opportunities, and inner rivalries of Apple's, nor did it harness as much capital and talent through the participation of other companies. Tandy's approach got the company out front fast; in 1979, it had sales of $95 million compared with Apple's $47.9 million. However, Tandy's tight control of its ecosystem ultimately led to slower growth at a time when establishing market share and a large user base was essential to success. By 1982, Apple's $583.1 million in sales had decisively passed Tandy's $466.4 million. Meanwhile, a third business ecosystem emerged in the early days of personal computing. It never rivaled Apple's or Tandy's in size, but it did help IBM enter the fray. This third ecosystem centered around two software companies: Digital Research and Micropro. In 1977, Digital Research made its software operating system CP/M available independent of hardware. That separation allowed almost any small manufacturer to assemble components and put out a usable personal computer. Overnight, a variety of small companies entered the business, building on the same Zilog microprocessor used in the early Tandy machines. In 1979, Micropro brought out a word processor that ran on CP/M-based machines. Wordstar was the first truly powerful word processor, and it took an important group of potential PC customers - The Evolutionary Stages of a Business Ecosystem Cooperative Challenges Competitive Challenges Work with customers and suppliers to define the new value proposition around a seed innovation. Protect your ideas from others who might be working toward defining similar offers. Tie up critical lead customers, key suppliers, and important channels. Expansion Bring the new offer to a large market by working with suppliers and partners to scale up supply and to achieve maximum market coverage. Defeat alternative implementations of similar ideas. Ensure that your approach is the market standard in its class through dominating key market segments. Leadership Provide a compelling vision for the future that encourages suppliers and customers to work together to continue improving the complete offer. Maintain strong bargaining power in relation to other players in the ecosystem, including key customers and valued suppliers. Self-Renewal Work with innovators to bring new ideas to the existing ecosystem. Maintain high barriers to entry to prevent innovators from building alternative ecosystems. Maintain high customer switching costs in order to buy time to incorporate new ideas into your own products and services. Birth HARVARD BUSINESS REVIEW May-June 1993 77 Automobiles: An Old-Fashioned Timeline An ecological approach can be used to analyze the evolution of any major business. However, a look at how the old-line automobile companies evolved reveals a different time scale than that of almost any new business today. Historically, the evolutionary stages of an established ecosystem like Ford's or GM's often took decades to play out; but now businesses can be born and die in a matter of years. Managers used to focus on directing the action within a particular stage rather than on how to move from one stage to another. Yet transition between stages has currently become a managerial fact of life. The major U.S. automobile ecosystems took about three-quarters of a century to evolve, a phenomenal length of time compared with the rise and fall of hightech businesses like personal computers. However, early automobile executives were well aware of the need to forge a community of suppliers and customers. Birth of the Horseless Carriage. The late 1800s were a time of experimentation, as the first automobile pioneers struggled to grasp the potential of individualized, motorized transportation. Ransom E. Olds and a handful of others established viable automobile business ecosystems by the turn of the century. Their machines worked reasonably well, were accepted by a small but dedicated number of customers, and could be profitably produced. Expansion Battles. The next 20 years carried the automobile business deep into the second stage of ecological competition. In 1904, William C. Durant began building what would become General Motors. Henry Ford founded the Ford Motor Company, and, in 1908, he introduced his mass-produced, mass-marketed Model T. Near-legendary battles between Ford and GM ensued- struggles as much for soul and future definition of the business as for simple market share. Ford's approach was based on vertical integration, carefully engineered production, and product simplicity. Ford's ecosystem had what we now would call \"scalability\"; by 1914, his company produced over 267,000 cars and held 48% of the market. Durant's strategy for GM, however, was based on acquisitions of early companies, marketing might, sales coverage, and product variety. Durant's ecosystem captured market share by pooling and integrating the markets and the production facilities of a variety of smaller companies. However, by 1920, General Motors had nearly collapsed because of the inability of Durant's management systems to control such a complex collection of business entities. From about 1910 to 1930, industry leaders directed the large expansion of the automobile market, reconfiguring the major ecosystems in the process. Alfred P. 78 Sloan's design for General Motors, initiated in 1920, is most notable and involved the simultaneous ouster of Durant. Sloan's design specifically allowed for the management of a complex business ecosystem by breaking up the diverse company into product lines, which, in turn, could be focused like Ford's mass-produced lines. Sloan also centralized financial oversight of decentralized product lines, and GM became the prototype of the modern multidivisional company. Community Leadership. By the 1930s, battles for community leadership and bargaining power revolved around the principal supplier to the auto industry: labor. In the late 1920s, around 500,000 people worked in the Detroit area car factories. Working conditions were dangerous; one auto body plant was known as \"the slaughterhouse.\" But by the mid-1930s, the United Auto Workers Union had formed. In 1937, the UAW achieved a landmark victory when GM recognized the union as an official representative of its employees. Over time, organized labor brought workers crucial bargaining power, which the union used to force the companies to share the spoils of victory. The tug-ofwar between workers and companies continued for decades, mediated with varying effectiveness by the U.S. government. While it protected workers, this form of ecosystem struggle also carried with it high costs: work-rule rigidity and the polarization of workers and management. These costs would come back to haunt the U.S. automobile business in the next stage of ecosystem development. The Threat of Obsolescence. Labor-management struggles continued into the 1970s, until both sides were driven together by a much deeper crisis: the obsolescence of the management approaches, business practices, and systems of production that had been only incrementally improved since the 1920s. The near collapse of the U.S. automobile business came, of course, at the hands of the Japanese. The Toyota ecosystem, for one, was capable of unheard-of levels of product variety, quality, and efficiency at the time. This powerful new business ecosystem was based on a combination of customer-focused design, concurrent engineering, flexible manufacturing, dedicated workers, and networks of suppliers, all tied together through statistically refined management practices. Therefore, the automobile industry, as traditionally defined, found itself in a full-fledged ecological war, defending against a new wave of business ecosystems. Self-renewal proved difficult, and companies like Ford and Chrysler had nearly collapsed by the late 1970s. The superiority of Japanese approaches ultimately forced the transformation of the world automobile business into what we know today. HARVARD BUSINESS REVIEW May-June 1993 ECOLOGY OF COMPETITION writers and editors - by storm. Demand for CP/M In the end, one business ecosystem may triumph, machines soared, fueling the growth if not the foror rival ecosystems may reach semistable accomtunes of small companies like Morrow and Kaypro. modations. Think of a hardwood forest that borders But during the first stage of any business ecosysa grassland. The zone of conflict at the boundary tem, co-evolving companies must do more than may shift from year to year, but it never completely satisfy customers; a leader must also emerge to iniwipes out either ecosystem. tiate a process of rapid, ongoing improvement that In general, two conditions are necessary for Stage draws the entire community toward a grander fu2 expansion: (1) a business concept that a large ture. In the Apple and Tandy ecosystems, the hardnumber of customers will value; and (2) the potenware companies provided such leadership by studytial to scale up the concept to reach this broad maring the market, defining new generations of ket. During the expansion stage, established comfunctionality, and orchestrating suppliers and partpanies can exercise enormous power in marketing ners to bring improvements and sales, as well as in the to market. In the CP/M ecomanagement of large-scale system, however, the hardproduction and distribution, ware companies were beliterally crushing smaller deviled by rivalry among ecosystems in the process. themselves. Infighting kept IBM, for example, entered down prices and profit marthe personal computer busigins, and none of the CP/M ness in 1981. In contrast to companies could afford its own history and culture Compete against other ecosystems heavy advertising programs. of vertical integration, IBM In Stage 1, established followed and extended the to control strategic markets. companies like IBM are ofApple model of building a Stimulate demand for your product community of supporters. ten better off waiting and or service offerings. watching carefully as a new IBM took on partners and market sorts itself out. The opened its computer archiMeet demand with adequate supply. tecture to outside suppliers. iterative process of trying out innovative ideas and Moreover, it adopted a midiscovering which solutions croprocessor from Intel that are attractive to customers incorporated all of the inis hard to accomplish in a traditional corporate culstructions available in the Zilog microprocessor in ture. And the diverse experimentation that thrives Tandy and CP/M machines. And IBM licensed MSin an entrepreneurial scene provides more \"genetic DOS, a software operating system from then tiny diversity\" from which the market can ultimately Microsoft, which was almost a near clone of CP/M. select the fittest offering. As a result, Wordstar and other popular application Established companies can subsequently repliprograms could easily be ported over to the IBM PC. cate successful ideas and broadcast them across One of the most important managerial chala wider market. In other words, they can enter the lenges in Stage 2 is to stimulate market demand market at Stage 2 by appropriating the developmenwithout greatly exceeding your ability to meet it. tal work of others. Meanwhile, original ecosystems IBM certainly stimulated demand for its new mathat succeed, like Apple's, do so by consciously nurchine through a combination of heavy brand adverturing a full community of partners and suppliers tising, distribution through Sears and other chanright from the start. nels, and building its own network of specialty stores. By anyone's measure, IBM's approach to exn Stage 2, business ecosystems expand to conpanding its PC ecosystem was a major success. Its quer broad new territories. Just as grasses and personal computing business grew from $500 milweeds rapidly cover the bare, scorched ground lion in 1982 to $5.65 billion by 1986, and IBM's left after a forest fire, some business expansions ecosystem rapidly dominated the market. meet little resistance. But in other cases, rival However, IBM also generated much more deecosystems may be closely matched and choose to mand than it could meet. The company maintained attack the same territory. Direct battles for market high prices, which encouraged others to enter the share break out. Fighting can get ugly as each market by setting a high price umbrella under ecosystem tries to exert pressure on suppliers and which they could thrive. Compaq, for example, becustomers to join up. came the fastest company to join the Fortune \"500\" Expansion: Capturing Territory I HARVARD BUSINESS REVIEW May-June 1993 79 ECOLOGY OF COMPETITION based on supplying machines to meet demand in ers that constrain these followers from becoming the IBM ecosystem. leaders in Stage 3. IBM did its best to keep up with demand. In the early 1980s, it invested directly in several key suphile the lion and antelope are both part of pliers to help it grow fast enough to meet the mara healthy savanna ecosystem, they also ket. Intel, for example, received $250 million from struggle with each other to determine to IBM in 1983. Concerned about its image as an inwhat extent each species expands within it. Simisensitive behemoth, as well as possible antitrust larly, in business ecosystems, two conditions conobjections, IBM managers carefully assured these tribute to the onset of the leadership struggles that suppliers that the help came without any strings are the hallmark of Stage 3. First, the ecosystem attached. must have strong enough growth and profitability IBM's relationships with suppliers were basically to be considered worth fighting over. Second, the nonexclusive. Obviously, suppliers like Intel, Mistructure of the value-adding components and procrosoft, and Lotus were happy to help the success of cesses that are central to the business ecosystem Compaq and others because it allowed them to dimust become reasonably stable. versify the risk of overdependence on IBM. For its This stability allows suppliers to target particular part, IBM was flush with more demand and success elements of value and to compete in contributing than it knew what to do with. Top managers didn't them. It encourages members of the ecosystem to focus on slowing the development of clone makers consider expanding by taking over activities from and nonexclusive suppliers - or keeping crucial elethose closest to them in the value chain. Most of ments of value like the microprocessor in-house. all, it diminishes the dependence of the whole At first, IBM didn't attack new competitors within ecosystem on the original leader. It's in Stage 3 that its ecosystem through the courts, through special companies become preoccupied with standards, inpromotions, or by lowering terfaces, \"the modular orgaits own prices. nization,\" and customerHowever clear the threat supplier relations. from the rest of the pack apFor example, by the midpears to us now, at the time, 1980s, the IBM PC technical architecture defined the de IBM and its business partfacto business structure for ners were pleased. By 1986, the personal computer busithe combined revenues of ness as a whole. Virtually companies in the IBM ecoGuide the ecosystem's investment any company could figure system were approximatedirections and technical standards. out how to make compoly $12 billion, dwarfing the Make sure the ecosystem has a nents and ser vices that Apple ecosystem's revewould dovetail effectively nues of approximately $2 robust community of suppliers. with other elements of the billion. IBM's leadership alMaintain bargaining power by conPC ecosystem. Of course, so forced Tandy and essentrolling key elements of value. this was a mixed blessing tially every other non-Apple maker of personal computfor IBM. The openness of its ers to dump their propricomputer architecture encouraged third parties to etary designs and offer IBM support it, dramatically accelerating the ecosysPC compatibles. tem's growth. Yet this same openness decreased the In contrast with IBM, the story of Wal-Mart's redependence of suppliers on IBM's leadership, laying tailing ecosystem shows how top management can the foundations for Stage 3 \"clone wars.\" take the right precautions when a business is exLotus, Intel, Microsoft, and other suppliers startpanding (see the insert \"The Evolution of WalMart: Savvy Expansion and Leadership\"). In genered working together to determine common stanal, Stage 2 rewards fast expansion that squeezes dards for hardware and software, with and without IBM's involvement. Other ecosystem members competing ecosystems to the margin. But managers welcomed this new leadership since it seemed fairmust also prepare for future leadership and leverage er to suppliers and more innovative than IBM's. in the next stage. To do so, companies need to Belatedly, IBM sought to enforce its patents maintain careful control of customer relationships against clone makers, seeking licenses from major and core centers of value and innovation. Moreover, players - one of the many strategies that failed. they must develop relationships with their suppli- W Leadership: The Fight for Control in an Ecosystem 80 HARVARD BUSINESS REVIEW May-June 1993 A grim milestone of sorts was achieved in 1989 In addition, central companies reinforce their when clone shipments and product shipments from roles by making important innovative contribuother smaller companies bypassed those of major tions to the performance of the ecosystem as a personal computer manufacturers. Thus IBM was whole. Intel, for instance, has enormous scale adrelegated to competing head-on with myriad \"box vantages in the fabrication of microprocessors. Its makers.\" IBM still retained a large share of the chip volumes allow it to work out fabrication-promarket but only through offering extensive discess advances sooner than other chip vendors. Ironcounts to large volume purchasers. ically, IBM held a license to manufacture IntelWhich brings us to the designed microprocessors. new structure of today's With its large volumes dur\"Microsoft-Intel\" ecosysing the expansion stage, tem: Microsoft, with gross IBM could have been the margins estimated at 80%; one taking the fabrication Intel, with gross margins of and price/performance lead 40% and 50% on its new in chips - and it could have chips; and IBM's PC busidenied Intel the scale to Track new trends that may upend ness with margins of about keep up. the ecosystem. 30%, a far cry from the 70% Finally, followers value a to 90% margins in its mainBuild a management team that can, central contributor because frame business. if necessary, start a new ecosystem. of its grip on customers. End In Stage 3, bargaining users are drawn to Microsoft Balance stability and change by inpower comes from having operating systems and Intel something the ecosystem chips because so many softcorporating new innovations. needs and being the only ware applications are availpractical source. Sometimes able for them. In turn, develthis sole-source status can opers keep turning out such be established contractually applications because they or through patent protection. But fundamentally, it know Microsoft and Intel are customer gateways. depends on constant innovation - on creating value To some extent, these two companies achieved that is critical to the whole ecosystem's continued their current central position by being in the right price/performance improvement. During expanplace at the right time - that is, by serving IBM. Insion, IBM didn't find a way to keep innovating tel and Microsoft clearly appreciate what they have or even to achieve economies of scale. Power shiftnow and are working effectively to maintain their ed to chips and software, areas in which IBM did central contributions. Still, some companies like not excel. Wal-Mart have systematically gone about building Now both Intel and Microsoft have bargaining a strong ecosystem, one that guarantees a leading power through control of a critical component. role for themselves. Each is a strong leader and plays the role of central In any case, for dominant companies, the expanecological contributor. Central contributors mainsion and leadership stages of an ecosystem can tain the much-coveted chokehold within a busimake or break them. In Stage 3, lead producers ness ecosystem. In short, other members can't live must extend control by continuing to shape future without them. This central position enables them directions and the investments of key customers to bargain for a higher share of the total value proand suppliers. And for healthy profits, any company duced by the ecosystem. For example, Intel and Miin the ecosystem - leader or follower - must maincrosoft have gross margins that are almost double tain bargaining power over other members. the average for their whole ecosystem. tage 4 of a business ecosystem occurs when Central contributor status is maintained in part mature business communities are threatened by the investments others have made in being folby rising new ecosystems and innovations. Allowers. Hardware and software vendors have made ternatively, a community might undergo the equivheavy investments in Microsoft operating systems alent of an earthquake: sudden new environmental and in applications that work with Intel chips. conditions that include changes in government regSwitching to other vendors would be risky and exulations, customer buying patterns, or macroecopensive; if possible, other co-evolving companies nomic conditions. Moreover, these two factors redon't want the burden of learning how to work with inforce each other. An altered environment is often a new leader. Self-Renewal - or Death S HARVARD BUSINESS REVIEW May-June 1993 81 ECOLOGY OF COMPETITION The Evolution of Wal-Mart: Savvy Expansion and Leadership An ecological analysis of Wal-Mart reveals how a relatively small company, starting in a rural area of the United States, could turn its original isolation to advantage by creating a complete business ecosystem. Wal-Mart developed and continues to refine an offer that customers find nearly irresistible: low prices on a variety of brands as diverse as Gitano jeans and Yardman lawn mowers. Moreover, CEO Sam Walton managed the company's expansion superbly and increased bargaining power during the leadership stage. The Birth of Discounting. In the early 1960s, Kmart, Wal-Mart, and other discounters recognized that the Main Street five-and-dime was giving way to the variety store. And variety stores, in turn, were threatened by the large discount store. In order to buy a wide range of goods at low prices in one location, customers were increasingly willing to get into cars and drive to malls or other non-Main Street locations. Kmart and Wal-Mart appeared on the discount scene at about the same time. The Kmart stores were actually owned by old-style S.S. Kresge, which reinvented itself as a suburb-oriented discount retailer, with big stores located near existing malls and towns of more than 50,000 people. Kmart stores carried items aimed at the lower end of suburban tastes. By the late 1960s, Wal-Mart had worked out the basic structure of its own business ecosystem: Wal-Mart stores, which supplied a variety of well-known brands, were located in relatively sparsely populated areas. The company went into towns of 5,000 people, particularly where several of these towns might be served by one store. Wal-Mart products were up to 15% cheaper than those available in \"mom-and-pop\" stores. While the original Wal-Mart locations could support one store, the customer population wasn't large enough to maintain two rival discounters. Thus once Wal-Mart established a store in a particular area and had beaten back weak local retailers, it was seldom threatened with future local competition from other discounters, including Kmart. Wal-Mart Takes Off 82 HARVARD BUSINESS REVIEW May-June 1993 Expansion: Planning for a Chokehold. Once its business strategy was up and running in a number of discount stores in the American South and Mid-West, Wal-Mart's top executives concentrated on developing organizational capabilities that would let it scale up successfully. They were obsessed with three things: Building a set of incentives that would ensure employee commitment to local stores, which led to a complex system of training, oversight, bonuses, and stock-purchase plans for workers. Managing communication and control of a network of remotely located stores, which required close monitoring of a carefully drawn set of measures that were transmitted daily to Wal-Mart headquarters in Bentonville, Arkansas. Setting up an efficient distribution system that allowed for joint purchasing, shared facilities, systematic ordering, and store-level distribution of a large number of different goods. This third obsession ultimately became Wal-Mart's trademark hub-and-spoke distribution system: warehouses served constellations of stores located no more than a day's drive from the center. In 1970, Wal-Mart went public to raise funds for its expansion. That same year, the company built its first hub-and-spoke distribution center - embarking on a strategy of targeting a large geographic area, setting up a distribution center, and then populating the area with as many stores as the territory would support. Wal-Mart not only filled the needs of customers in small towns but also saturated entire regions, making it uneconomical for competitors to enter as either distributors or local store owners. The number of Wal-Mart stores grew rapidly, from 32 in 1970 to 195 in 1978 - when the first fully automated distribution center opened - to 551 in 1983 - when Wal-Mart launched its own satellite, creating a communication network to keep in daily touch with its now far-flung empire. Leadership: Building Bargaining Power. By 1984, Wal-Mart's managerial agenda changed. What was in the birth and expansion stages a race to develop systems and conquer territory now became a concerted effort to build bargaining power. As the leaders of a highly successful and visible business ecosystem, Wal-Mart managers worked on continuing to assert the company's vision over other community members, including suppliers like Procter & Gamble, Rubbermaid, and Helene Curtis Industries. First, Wal-Mart resisted the temptation to charge higher prices in the markets and regions it dominated. HARVARD BUSINESS REVIEW May-June 1993 Instead, top managers still viewed each market as \"contestable\" - as a potential opening for rivals if WalMart ceased to give the maximum possible value to customers. Continued customer leadership, in turn, enhanced the Wal-Mart brand and further cemented the company's place in the minds and buying habits of consumers. Wal-Mart's system of \"everyday low prices,\" in which there's no need for weekly sales or special promotions, has now become a standard in discount retailing. Second, Wal-Mart - now a very large and powerful channel to customers - started putting heavy pressure on suppliers to keep their prices down. Moreover, WalMart compelled its suppliers to set up cross-company distribution systems to attain maximum manufacturing efficiency. For example, in 1987, Wal-Mart and Procter & Gamble reached an unprecedented accord to work together through extensive electronic ordering and information sharing between the companies. In return, Wal-Mart gives better payment terms than the rest of the retailing industry: on average, Wal-Mart pays its suppliers within 29 days compared with 45 days at Kmart. Third, Wal-Mart continued to invest in and enhance its own fundamental economies of scale and scope in distribution. By the leadership stage, distribution had become the crucial ecological component of the WalMart ecosystem. In fact, Wal-Mart's distribution chokehold has allowed the ecosystem as a whole to triumph over others like Kmart's. While suppliers, big and small, may chafe under Wal-Mart's heavy hand, it's also clear that most of them need this particular leader to survive. The graph \"Wal-Mart Takes Off\" is a testament to the company's dominance and bargaining power in the leadership stage. Finally, Wal-Mart has extended its reach into adjacent territories and ecosystems. In 1983, Wal-Mart entered the membership discount market with its Sam's Club, which by 1992 included 208 clubs that contributed over $9.4 billion in revenues. In 1990, WalMart incorporated another ecosystem by acquiring McLane Company, the nation's largest distributor to the convenience store industry. McLane, under WalMart's control, now serves about 30,000 retail stores, including 18,000 convenience stores. And in 1992, Wal-Mart also acquired the distribution and food processing divisions of Southland Corporation. Southland operates a large chain of 7-Eleven convenience stores, and this acquisition added as many as 5,000 more 7-Eleven stores to the McLane/Wal-Mart customer base. 83 ECOLOGY OF COMPETITION more hospitable to new or formerly marginal business ecosystems. In fact, how a dominant company deals with the threat of obsolescence is the ultimate challenge. Just because Microsoft and Intel are leaders now doesn't mean their current ecosystem is immortal. Nor does it mean that Microsoft NT (\"New Technology\" operating software) will form the basis for its successor. After all, Novell and UNIX Systems Laboratories have merged and will put forth a new generation of software, looking to strengthen a new ecosystem. Both Hewlett-Packard and Sun Microsystems remain strongly entrenched. And Motorola is now manufacturing a new generation microprocessor to be sold by both IBM and Apple, along with a jointly developed new software operating system. Leading successive generations of innovation is clearly crucial to an ecosystem's long-term success and its ability to renew itself. Today's pharmaceutical companies provide some interesting insights into three general approaches to selfrenewal, which can be used alone or in combination: (1) dominant companies can seek to slow the growth of a new ecosystem; (2) they can try to incorporate new innovations into their own ecosystems; or (3) they can fundamentally restructure themselves to try coping with a new reality. During the past few decades, pharmaceutical companies have operated under a relatively consistent, if largely implicit, social compact with government regulators. In exchange for investing heavily in product and process innovation, drug companies have been allowed comparatively high margins and protection from competition through patent laws and lengthy approval processes. Traditional pharmaceutical ecosystems, therefore, have evolved around three major functions: R&D, testing and approval management, and marketing and sales. Each of these functions is expensive, hard to perfect, and thus presents a barrier to new competitors. In the past, these functions were carried out within large, vertically integrated companies that did not, until recently, consider themselves networked organizations. In the 1980s, generic drug manufacturers that specialized in producing off-patent drugs posed a threat to the established pharmaceutical houses. The dominant companies responded by blocking these rival ecosystems in order to minimize their expansion. This included lobbying to slow genericdrug enabling legislation and to reinforce the natural conservatism of the U.S. Food and Drug Administration. Well-funded marketing and sales efforts convinced thousands of individual physicians to continue prescribing mostly branded drugs. While the generic drug manufacturers were able to establish alternative ecosystems, their penetration of the market has been held to about 30%, with little price cutting by the dominant companies. Meanwhile, a variety of small biotechnology start-ups posed an even greater threat to the traditional pharmaceutical powerhouses. In general, biotech researchers concentrate on isolating complex substances that already exist in the human body and finding ways to manufacture them - for example, human insulin and human growth hormone. As many as one biotech try in ten may prove successful, which keeps the R&D cost down to between $100 million and $150 million per marketable product. Compare this with the traditional pharmaceutical average of 10,000 chemical tries to identify one marketable drug - and R&D costs of $250 million to $350 million per product. Many of the founders of and investors in biotechnology start-ups believed that low R&D costs would provide the basis for creating whole new business ecosystems that could compete with the established drug companies. For example, Genentech, one of the pioneering biotech companies, clearly intended to establish itself as a full competitor. By the mid-1980s, Genentech had five products in the market and was marketing three itself. It licensed its first two products: alpha-interferon to Hoffmann-La Roche and insulin to Eli Lilly. Using the cash from these licenses, Genentech sought to manufacture and market human growth hormone and tissue plasminogen activator on its own. Yet in 1990, 60% of Genentech was sold to HoffmannLa Roche for $2.1 billion. A similar fate has befallen almost all of the original biotech companies. In essence, these companies misjudged the difficulties of mastering the testing and approval pro- From an ecological perspective, it matters not which particular ecosystems stay alive; it's only essential that competition among them is fierce and fair. 84 HARVARD BUSINESS REVIEW May-June 1993 cess. The first biotech managers bet on the assumption that testing and approval would, like R&D, be less expensive and problematic than it was for their traditional competitors. Since biotech products were existing molecules already resident in the human body, these products would presumably require much less testing than synthetic chemical compounds. However, the FDA approval process in the United States, which grants access to the most important market worldwide, has not borne this out. From 1981 to 1991, only 12 biotech products were approved for general marketing. Strapped for cash and unable to raise much more from their original investors, most biotech companies ended the 1980s in no position to lead their own business ecosystems. Biotech managers and investors were attracted to alliances with traditional companies and thus merged new business ecosystems with powerful existing ones. In turn, dominant companies like Merck, Eli Lilly, and Bristol-Myers began to think like business ecosystem builders. In order to snap up licenses, patents, and talent to strengthen their own R&D, these companies affiliated themselves with the biotech companies rather than simply blocking their new rivals. Of course, the leaders of a mature business ecosystem sometimes have no choice but to undertake profound structural and cultural changes. Pharmaceutical ecosystems now face new threats and a profoundly altered environment. The social compact to protect drug company profits in exchange for product and process innovation is breaking down. The public, government, and corporations all want health care costs reduced. Drug company leaders see lean times ahead as they confront the possibility of price and profit caps, as well as consolidated purchasing of drugs by HMOs and government agencies. Responding to this environmental shift will force changes across all major functions. Companies will probably have to limit R&D spending and focus it carefully. Managers are likely to design a testing and approval process that highlights not only efficacy but also cost/benefit performance of new treatments. Finally, companies will probably market and sell less directly to individual physicians, focusing instead on negotiations with experts who represent third-party payers and government. But despite the difficulties of such a complex business environment, managers can design longevity into an ecosystem. During the expansion and leadership stages, for instance, companies can work hard to micro-segment their markets, creating close, supportive ties with customers. These customers will then remain committed to a particHARVARD BUSINESS REVIEW May-June 1993 ular ecosystem long enough for its members to incorporate the benefits of new approaches. And visionary executives like Merck's Roy Vagelos can sometimes lead an ecosystem so that it rapidly and effectively embraces anticipated developments - be they new technologies, regulatory openings, or consumer trends. Ultimately, there is no substitute for eternal vigilance. As Intel's Andy Grove noted recently, \"Only the paranoid survive.\" C learly, pharmaceutical companies - and any other venture threatened by continual innovations - can no longer allow their particular ecosystems to evolve without direction. Using an ecological approach, executives can start making strategic changes by systematically questioning their company's current situation: Is the company linked with the very best suppliers and partners? Is the company betting its future on the most promising new ideas? Are suppliers leading the way in commercializing innovation? Over the long run, how will the company maintain sufficient bargaining power and autonomy to guarantee good financial returns? Examining a company's key competitors from a business ecological point of view is also important: What hidden web of customer and supplier relationships have competitors worked to develop? Who do they depend on for ideas and supplier support? What are the nature and benefits of those relationships? How do these compare with what the company has? And to prepare the ground for organizational breakthroughs, managers need to consider how the work of their company might be radically different: What seed innovations might make current businesses obsolete? What would it take to catalyze a cluster of ideas into a new and vital business ecosystem? What type of community would be required to bring these new ideas to the widest possible market? Asking these questions, let alone acting on the answers, has become a difficult necessity for all companies. Superficially, competition among business ecosystems is a fight for market share. But below the surface, these new competitive struggles are fights over who will direct the future. Yet it's precisely in the role of conscious direction that a strictly biological metaphor is no longer useful. Business communities, unlike biological communities of co-evolving organisms, are social systems. And social systems are made up of real people who make decisions; the larger patterns are maintained by a complex network of choices, which depend, at least in part, on what participants 85 ECOLOGY OF COMPETITION are aware of. As Gregory Bateson noted, if you change the ideas in a social system, you change the system itself. I anticipate that as an ecological approach to management becomes more common - as an increasing number of executives become conscious of co-evolution and its consequences - the pace of business change itself will accelerate. Executives whose horizons are bounded by traditional industry perspectives will find themselves missing the real challenges and opportunities that face their companies. Shareholders and directors, sensing the new reality, will eventually remove them. Or, in light of the latest management shifts, they may have already done so. Unfortunately for employees and investors, this often occurs only after the companies involved have been deeply damaged. Companies that once 86 dominated their industries, as traditionally defined, have been blindsided by new competition. Whether such companies can find the appropriate leadership to renew the ecosystems on which their future depends remains an open question. If they cannot, they'll be supplanted by other companies, in other business ecosystems, that will expand and lead over the next few years. For the individuals caught up in these ecosystem struggles, the stakes are high. As a society, we must find ways of helping members of dying ecosystems get into more vital ones while avoiding the temptation of propping up the failed ecosystems themselves. From an ecological perspective, it matters not which particular ecosystems stay alive; rather, it's only essential that competition among them is fierce and fair - and that the fittest survive. Reprint 93309 HARVARD BUSINESS REVIEW May-June 1993 Harvard Business Review HBR Subscriptions Harvard Business Review U.S. and Canada Subscription Service P.O. Box 52623 Boulder, CO 80322-2623 Telephone: (800) 274-3214 Fax: (617) 496-8145 Outside U.S. and Canada Tower House Sovereign Park Lathkill Street Market Harborough Leicestershire LE16 9EF Telephone: 44-85-846-8888 Fax: 44-85-843-4958 American Express, MasterCard, VISA accepted. Billing available. 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