By Dr. Vijak Haddadi
(From May 13, 2015)
What’s the best way for a venture to make money and keep making money? No-brainer, you may say, make great products, keep innovating them and bring them to market. You’d be perfectly on point but this answer doesn’t tell you much about how a venture has to position itself in order to accomplish it. Orthodox business strategy on the other hand has a lot to say about positioning. Going back to Harvard-based business school guru Michael Porter and his various strategy models – still widely touted by many consultants, business intelligence professionals and MBA’s across the world as the holy grail of strategic analysis – conventional business wisdom maintains that the key lies in conquering and defending as large a chunk of a given market as possible. The venture should use all means possible to capture as much as it can and then entrench its gains behind structural barriers and other hopefully impenetrable advantages, so as to defend its embattled position against the inexorable onslaught of competitors. In a nutshell, the market is a battlefield and the venture’s task is to build a heavily fortified fortress on it while constantly trying to expand its territory and bring new land inside the fortress walls.
As we shall see, this view is rather flawed and out of touch with the reality of how value is created and allocated in today’s business landscape. If followed through, the orthodox us-versus-them perspective could actually lead a venture on a lopsided and counterproductive path and hinder it from maximizing its true potentials. It might seem counterintuitive at first but focussing solely on capturing as much as you can may eventually leave you with less than following a sensible balance between sharing and conquering, creating and capturing. Why? Because making money in a successful and sustainable way is essentially the by-product of a synergetic interplay between shared value creation and exclusive value capturing activities. If that seems to come out of left field now, just bear with me. It will be thoroughly explained and explicated in this piece of writing. Moreover, along the way, Porter’s concept of the value chain – the central conceptual tool for value analysis in orthodox business strategy – will be replaced by the new and fresh concept of interconnected value spheres in business ecosystems.
Value Creation & Value Capture Essentials
But let’s begin by getting a grip on the fundamental concepts and processes involved. Before you can make any money you first have to somehow create value for other people. How does that happen? There are many ways to create value. You can enable people to do something they couldn’t do before, empower people to do something better they were already doing, enhance people’s experience of something or enable them to experience something entirely new. All of these activities somehow expand people’s capacities and possibilities, which in turn is something that people are willing to pay for. This is true regardless of whether your venture is providing basic sustenance, indulging extravagant and luxurious tastes, or revolutionizing the way people date, communicate or travel.
But creating value alone does not automatically translate into making money. Friends, charities and all sorts of nice people create tremendous amounts of value, generally without receiving monetary remuneration. What defines a business venture is not just its ability to create value but also its ability to charge people for that value, or in other words, to capture value. These two processes are at the heart of business activity. First some kind of value is created and then that value is captured through monetization. It’s pretty simple actually. If you only create value but don’t capture value you’re not a business but a charity. If you only capture value but don’t create any value you’re also not a business but a criminal enterprise. If you both create and capture value, you have a real business venture.
Naturally, understanding the exact relation between value creation and value capture is key to understanding how businesses make money. But this relation depends entirely on the setting in which it takes place. In the most simple type of setting you create something of value and then immediately capture that same value by receiving a monetary appreciation from a direct beneficiary. Say you make really nice lemonade at home and then go to the park on a sunny day to sell your beverage to park dwellers who pay you on the spot for the exquisite refreshment your product provides. In this setting there is no gap between value creation and monetary appreciation or value capture. The interplay is perfectly closed and immediate which is in turn due to the simple make-and-sell setting.
Co-Creation & Coopetition in Ecosystems
As socioeconomic reality evolves, the systemic settings in which value activities take place become more and more complex. Intermediaries, additional channels and extended relations of connectivity and interdependency enter into the picture, interlinking a multitude of value activities through flows of goods, information and digital currencies. Things really start to get messy and complicated. By the time we get to the kind of complexity that’s involved in the business ecosystems of our highly networked economy, we’ll see that value creation and value capture activities are generally separated both spatially and temporally and typically involve a wide range of differing actors and participants. As opposed to just making something and selling it on your own, it’s now a vast range of different actors in extensive networks who are jointly making things that are being monetized through diverse channels and routes.
Let’s look at an example. Say your venture has created an app which you are now going to sell through Google Play or the Apple App Store. In this case the value that your app delivers to its eventual users (the new potentials and capacities) will have been created by you, the creative entrepreneur, plus a vast number of other actors and participants including the makers of mobile communication devices (Samsung, LG, Motorola, Sony, Apple, etc.), the makers of the OS your app runs on (Android or iOS), the developers who wrote your app, the designers who created your app’s icons and interface, your sales and marketing team, the makers of the software you use and rely on, plus even the makers of competing apps who’s products contribute to the strength and diversity of the platform you are using. All of these actors are part of a business ecosystem which jointly creates value.
But that’s not even all. Say, your venture is doing something comparable to Spacefy – a promising Toronto-based startup which uses the possibilities of the sharing economy to hook participants up with special event locations used by artists, performers, photographers, musicians, and so on. If you are making an app for Spacefy you don’t just depend on the aforementioned group of contributors and supplementaries but also on the inputs of those who discover and curate locations and eventually those who use and showcase the locations as elements of their own creative portfolios. In other words, you are co-creating value together with your customers and a whole bunch of other actors in your extended network. Just like in nature, where we have many levels and layers of ecosystems (the whole forest, the lake in the forest, a particular population of animals in that lake, etc.) what we see here is also many levels and layers of ecosystems at work. There are the gigantic competing macro ecosystems of Android and Apple, each about one to two hundred billion dollars in size, and there are various micro ecosystems within these larger systems, including the one around your app which involves certain chunks of the app platform’s infrastructure as well as the customers who participate in your particular value vision.
So what do ventures’ value activities look like in the ecosystems setting of today? Let’s get our philosophical perspective right before getting into the nitty gritty of results and applications. On the highest macro level we are all interconnected as system Earth – the integrated global economy and ecology of our planet. Below that we find a mind-boggling array of different systems and sub-systems, each like spheres of influence within which actors and processes are connected to create value. Spheres within spheres within spheres. This is exactly how we have to think of ventures and their value activities today. Ventures produce and thrive within spheres of co-creators in which they are nested and embedded. This is what we see, whether we look at health, biotech, automotive solutions or mobile applications. Everywhere, extensive networks of actors are bringing specialized knowledge and capacities together in order to jointly create value. But of course, everyone within such ecosystems also wants capture the co-created value and thus make money. Ecosystem actors stand in a relation of coopetition to each other – they cooperate on value creation while simultaneously competing on value capture.
Ecosystems Architectures As Key
So far so good. So, value creation in modern business ecosystems takes place through the co-creative efforts of a broad sphere of actors. But who captures value and how? Obviously, the case is no longer as clear cut as when you were selling home-made lemonade in the park. What happens in business ecosystems is that various actors are able to deploy a wide range of monetization strategies in order to capture value from various angles and spots within the ecosystem. Each venture within an ecosystem has access to a variety of monetization strategies, pricing strategies, price carrier choices, payer choices, price timing and commitment models, all in order to capture value through the payments of those who in some way use or benefit from the ecosystem. Crucially, the value you are able to capture in an ecosystem is not exactly the value you created. Value is co-created so it would be impossible anyway to determine exactly who created which part. Although everyone jointly creates value, who gets to capture value is largely determined by the structural properties of the ecosystem, or the ecosystem architecture, which allocates spots and positions to players, with some spots having a more privileged access to monetization routes than others.
But ecosystem architectures are not static. Each business ecosystem has a sort of DNA which is established through primary industry conditions and initial decisions of ecosystems founders, but this DNA evolves historically as industries develop and ventures within the ecosystem make important strategic choices. So when, for instance, Apple began in the late 1970s to involve hosts of independent developers, suppliers and retailers in mutually beneficial relations, it not only transitioned the more or less dormant industry of semiconductors into a new ecosystem of personal computers but also helped establish the central architectural features of the emerging personal computer ecosystem. That very same same ecosystem later evolved significantly when value capturing leadership shifted from the makers of hardware to the makers of operating systems and micro-processors in the late 1980s resulting in the meteoric rise of Microsoft, Intel, AMD, et al.
While a significant part of the features of ecosystems depend on market and industry conditions, it is still always also the entrepreneurial decisions of ventures which help establish clearly defined ecosystems architectures. Simply put, without the decisions of firms like Apple and Tandy, the semi-conductor industry would not have been transformed into the personal computing ecosystem. Once established, the entrepreneurial decisions of ventures result in the evolution and potentially even the revolution of whole architectures at certain key turning points. Different ecosystemic strategies pursued by key players can result in significant variety as to who gets to capture value and how. As Michael Jacobides from London Business School argues in this TEDx Talk, this variety can lead to completely different situations even within highly similar or even identical industries.
Thus in the ecosystem of French wines it is the growers and wineries who control most of the value capture mechanisms including branding and price setting, while in the ecosystem of Portuguese port wines that same power lies in the hands of shippers and exporters. Or to return to our example of the app developing venture again, depending on whether your app is operating within Google’s Android or within Apple’s iOS system you’ll be able to partake in various value capturing opportunities which are intrinsic to the architecture of the particular ecosystems, such as Apple’s Affiliate Program for developers or Google’s customary rounds of sharing ecosystem revenues with actors such as carriers, manufacturers and developers. Each of these app ecosystems has markedly different value creation and value capture opportunities (see diagrams on the side, courtesy of a very insightful 2014 Vision Mobile study on mobile megatrends) and once Amazon’s and Microsoft’s competing app platforms kick into gear, we are bound to see yet new and different forms of architectures and creation-to-capture dynamics.
As an app developer you have many immediate possibilities to monetize your app, including upsells, in-app purchases, ads, sponsorships, subscription models, sales referrals and shared sales networks with other apps. And while your value capturing decisions will not be able to change or revolutionize an entire vast ecosystem like Android’s app market, you may very well be able to influence the architecture of your own micro ecosystem which you are establishing with your customers and participants in your particular field. This is an even more salient consideration when your venture is potentially bringing into being a new local ecosystem, such as in the example of Spacefy, the venture that connects performers and location curators to hopefully become something like the Uber of event spaces. When you are trying to determine how a venture’s value activities can be designed to be sustainably profitable, you are well advised to consider the creation-to-capture dynamics that a given ecosystem architecture provides you with, as well as available strategies to influence this architecture. But how exactly should we go about analyzing value activities? We need conceptual tools to do the job.
How To Analyze Value – Porter’s Value Chain?
When analyzing a given situation or trying to determine strategies, a lot depends on the conceptual tools you are going to use. What is the tool most commonly used to analyze a firm’s value activities? Without a doubt, that has to be Michael Porter’s value chain. The concept is so ubiquitous in business parlance and analysis that one can hardly imagine it was literally unknown before Porter put it on the map. To be sure, people did think about value activities before Porter, but as long as the concept had not been clearly articulated and visualized in a now famous diagram (seen here on the right), it could not become an easily applicable staple for business analysis.
This is precisely the power of a concept. As philosophers know, a concept is not just a word or a name you give to something. It is a genuine thought design. A real concept is an arrangement of ideas which – as soon as you grasp it – allows you to see things from a new perspective and act accordingly. This is why having the right concepts to work with is such an essential requirement for success in any advanced domain from architecture to business. But the concepts we use may also limit our actions and our field of vision if they are no longer adequate to the reality they seek to grasp. This is exactly what is rapidly happening to the concept of the value chain. Devised in the 1980s, its genesis lies before the digital revolution and the age of all-embracing interconnectivity and therefore also before our full understanding of the power of networks and ecosystems.
While value creation now happens in interconnected ecosystems, Porter’s value chain envisions a value creation process that takes place entirely behind closed doors, without any interference from outside forces. Remember the image of the battlefield we drew up in the beginning of this text to characterize Porter’s orthodox vision of strategy? The beleaguered firm fortress on enemy territory, hermetically sealed off from its surroundings and fortified through structural barriers, with proprietary secrecy extending to all processes from research and development to procurement and operations. Porter’s value chain is fitting for a firm that operates in such a manner, that is to say, it makes sense for an industrial era firm that creates value in closed and isolated silos and then brings that value to market. Products are manufactured in a factory, according to secret methods, and are then sold outside.
While this vision may have been useful for a while for large, conventionally organized corporations, chiefly trying to catch up with the efficiency of Japanese car makers, in today’s complex reality of coopetitive value creation and value capture in business ecosystems the outlook is of very limited use and may, according to some, even be damaging to ventures and society as a whole. In terms of the examples used above, if you are making lemonade and selling it, your value creation activity is indeed a closed and sequential process which can be well represented by Porter’s value chain. The example may seem trivial but essentially industrial era type firms produced exactly in such a manner. Inputs are taken into sealed silos and are transformed step by step, under exclusion of outside interference, with each step adding value until then the final product is marketed and monetized. If you are such an industrial era firm, the value chain is fine for you. If you are a 21st century venture trying to innovate life sciences, social networks, health, education, or any other pressing concern of today, you need a new concept.
Time to Think of Value Spheres
As we have amply seen above, the reality of business in the information age has moved far away from the sort of production processes captured by Porter’s value chain. Value activities in modern business ecosystems are complex, dynamic and open while the value chain is closed and linear. Evidently, the concept needs to be updated or replaced. In this vein, Xavier Comtesse and Jeffrey Huang from ThinkStudio propose the Value Chain 2.0 in which value creating activities are replaced with open and participatory versions more apt at describing the reality of ventures in business ecosystems. Firm infrastructure is replaced by multistakeholder infrastructure, R&D behind closed doors is replaced by co-creation with customers, and so on, until all the building blocks of the vlaue chain are replaced with information age equivalents. But while this proposal succeeds in rethinking value activities in the non-linear and networked reality of the participatory economy, it still maintains the closed and sequential form of the model originally proposed by Porter. A further and more radical step has to rethink not just the content of the model but also its form.
Another fertile concept has been proposed and profitably utilized by Clayton Christensen, the acclaimed originator of the concept of disruptive innovation. Christensen speaks of value networks by which he understands the assemblage of suppliers and channels which support a given business model within an ecosystem. While value networks are a useful tool for understanding the technological interconnections and interdependencies and therefore the viability of innovations and the likelihood of disruptions, the concept does not really illuminate the whole spectrum of value creation and value capture activities.
In place of the value chain I hence propose a fresh notion – the concept of value spheres – a dynamic, holistic and open concept of value creation and value capture activities within business ecosystems. There are value creation spheres and there are value capture spheres. The value creation sphere represents activities that ventures pursue cooperatively with suppliers, customers, independent researchers, competitors, and complementaries, in order to co-create value. Value capture spheres then are arranged within a value creation sphere, and represent the reach of monetization activities that each venture posits in competition with other organizations in order to capture the co-created value. The accompanying diagram shows Porter’s well known value chain in relation to the value creation sphere. As we have seen, value creation in ecosystems takes place through co-creation and cooperation with various actors and participants. Open innovation takes the place of isolated R&D, viral marketing takes the place of traditional marketing, supply network management takes the place of supply chain management, and so on. Taken together, the activities of the value creation sphere generate value for an entire ecosystem.
Sustainable Capture-to-Creation Ratio
So the value creation sphere shows the value that’s jointly co-created by numerous participants in a localized ecosystem. To make money, a venture still needs to capture that value, a process we can envision through a second value sphere representing the scope and extent of value which any particular venture is able to capture. How do ventures establish their value capture sphere? They utilize the structural opportunities provided by a particular ecosystem architecture in order to capture from whatever spots and angles that are available, using the whole gamut of monetization methods and strategies mentioned above – direct product sales, subscription models, memberships, affiliate programs, sales referrals, channel rentals, and all kinds of redistribution mechanisms to take part in the monetization processes of other ecosystem players. So for any value creation sphere there is a multiplicity of smaller value capture spheres which slice up and distribute the created value among the various players. The value creation sphere indicates the whole pie jointly produced by an assemblage of co-creators while value capture spheres indicate the monetary portions that each venture individually and exclusively is able to carve out of the pie for itself.
Does that not simply mean that every venture should try to collaborate as much as possible on co-creating value while competing as fiercely as possible on capturing the largest chunk it can get of the jointly created pie? Not necessarily. Remember that the value represented by the value creation sphere is the total value that needs to be split up between all participants of an ecosystem. If you are a player in an ecosystem, and especially if you are a keystone or leading player, you have an interest in the health and resilience of your entire ecosystem since your ability to thrive and grow directly depends on the co-creative contributions of other ecosystem players. Surely there is nothing wrong with participants perishing who simply fail to compete – that’s nothing but natural selection after all – but nonetheless participants who create a lot of value for everyone will have to be able to capture value as well if you want them to go on doing what they are doing.
Let’s look at the example of the apps ecosystems once again to make this clear. What would happen if the lead players in one of the apps ecosystems, be it Google, Apple, Microsoft or Amazon, were to actually follow the orthodox business strategy mindset and were to deploy all available means to capture the largest chunk possible of their respective value spheres? Certainly each of these lead players could set up indomitable structural barriers that would allow it to capture most, if not all, of the value created in their ecosystems, while suppliers, supplementaries, developers, participants, and so on, would be reduced to an absolute minimum of value capture opportunities. It seems like Google or Apple could make more money this way, doesn’t it? Of course what would actually happen is that the lead player who acts in such a way would effectively kill his own ecosystem – in all likelihood causing mass exodus of participants and migration to alternative and more hospitable ecosystems. It’s clear that as a lead player or one that aspires to be one in any ecosystem, no matter if gigantically large or charmingly tiny, your real goal is not to capture as much value as you can. Rather your real goal is to obtain and maintain value capturing leadership, the ability to stay at the helm of value capturing activities within your ecosystem and establish a sustainably rewarding ecosystem architecture.
If you are capturing much more value than what you are creating – for instance by using structural barriers – you may actually hold back and damage your ecosystem, which will in time lead to more dynamic and equitable ecosystems to take over. If you are creating much more value than what you are capturing, you may be leaving money on the table. If you are a huge enterprise with tons of income you might actually choose to do so out of considerations for the growth of your ecosystem, but generally speaking this is not a recipe for sustainable success because the additional windfall gained by other ecosystem players could reward unproductive habits. As guiding rule, what every venture, and particularly any ecosystem’s lead ventures should rather aim for is to realize a sustainable capture-to-creation ratio – a relation between capturing and creation activities that makes sure the ecosystem keeps growing while maintaining value capture leadership as determining force of ecosystems architecture and capture opportunities (see diagram for representation). Put simply, the goal is not to get the largest piece of the pie that you can get right now but rather to make sure the pie keeps growing and you maintain authority over influencing the relative distribution of the pie.
These considerations are of equal value to the enterprises that lead our planet’s largest business ecosystems as well as to entrepreneurs and startup venturers who apply their zest, vision and enthusiasm to the creation of new venture ecosystems. Take the example of the multiplicity of micro-ecosystems that are now emerging in the field of new health solutions where wearable technology, mobile apps, implants and other biotech and advanced data analytics, are rapidly coming together to make possible a whole new level of holistic health monitoring and advisory services. To be sure, there are major health providers and insurances who attempt to establish major macro ecosystems in this field, but revolutionary entrepreneurial advances generally begin with the creation of micro ecosystems, for example in this case connecting health advisors, life coaches, nutritionists, doctors, data analysts, mobile app and wearable tech developers, and so on, with participating users. In an emerging ecosystem, all of these actors will contribute to the co-creation of value, while all will also deploy various means to capture value. As an entrepreneurial leader of emerging ecosystems in this field you will be well advised to take lessons about successful ecosystems architectures into account and to seek the establishment of a sustainably rewarding creation-to-capture ratio.
To return to the question set out in the beginning – paradoxically, ventures do not make the most money by trying to make as much money as they can. At least not in the long run. If you just focus on getting as large a piece of the pie as you can, you may be obstructing valuable opportunities for making sure the pie grows and keeps growing. Rather what produces significant and sustainable returns in the long run is to pursue a productive ratio between your value creation sphere and your value capture sphere. How ventures really make money and keep making money is by being ferociously passionate about co-creating value for participants together with a broad sphere of collaborators, and by taking on strategic leadership in the wise and productive distribution of that value among co-creators.