Digital Capital: Harnessing the Power of Business Webs

• Contracting costs. If every exchange requires a unique price negotiation and contract, then the costs can be totally out of whack with the value of the deal. Since Sony owns Epic Records, it does not need to negotiate a distribution deal when Epic signs a new artist like Fiona Apple.

• Coordination costs. This is the cost of coordinating resources and processes. Coase points out that with "changes like the telephone and the telegraph," it becomes easier for geographically dispersed firms to coordinate their activities. Industrial-age communications enable big companies to exist. Sony's internal supply chain includes finding and managing talent, and producing, marketing, and distributing recorded music.

    Coase says that firms form to lighten the burden of transaction costs. He then asks another good question. If firm organization cuts transaction costs, why isn't everything in one big firm? He answers that the law of diminishing returns applies to firm size: Big firms are complicated and find it hard to manage resources efficiently. Small companies often do things more cheaply than big ones.

    All this leads to what we call Coase's law: A firm will tend to expand until the costs of organizing an extra transaction within the firm become equal to the costs of carrying out the same transaction on the open market. As long as it is cheaper to perform a transaction inside your firm, says Coase's law, keep it there. But if it's cheaper to go to the marketplace, don't try to do it internally. When consumers and artists use the Net as a low-cost marketplace to find one another and "contract" for tunes, the Sonys of the world must face the music.

    Thanks to internetworking, the costs of many kinds of transactions have been dramatically reduced and sometimes approach zero. Large and diverse groups of people can now, easily and cheaply, gain near real-time access to the information they need to make safe decisions and coordinate complex activities. We can increase wealth by adding knowledge value to a product or service—through innovation, enhancement, cost reduction, or customization—at each step in its life cycle. Often, specialists do a better value-adding job than do vertically integrated firms. In the digital economy, the notion of a separate, electronically negotiated deal at each step of the value cycle becomes a reasonable, often compelling, proposition.

    This proposition is now possible because the Net is attaining ubiquity (increasingly mobile through wireless technologies), bandwidth, robustness, and new functionality. The Net is becoming a digital infrastructure of collaboration, rich with tools for search transactions, knowledge management, and delivery of application software ("apps on tap").

    Call it hot and cold running functionality and knowledge. This explosion, still in its early days, is spawning new ways to create wealth. A new division of labor that transcends the traditional firm changes the way we design, manufacture, distribute, market, and support products and services. Several examples illustrate the success enjoyed by companies that employ this new division of labor.

• MP3.com is a Web-based music distributor that uses, but does not control, the MP3 standard and that offers legal, non-pirated music. In September 1999, it listed 180,000 songs from 31,000 artists, ranging from pop to classical to spoken word. Music downloads are free and nearly instantaneous. Fans also purchased 16,000 CDs online for a typical price of $5.99.

• Global Sources is a b-web that provides manufacturers, wholesalers, and distributors with access to products from 42,000 Asian makers of computers and electronics, components, fashion items, general merchandise, and hardware.

• The GE Trading Process Network (GETPN) enables companies to issue fully documented requests for quotations to participating suppliers around the world via the Net, and then to negotiate and close the contract. Through a partnership with Thomas Publishing Company, a publisher of buying guides, GETPN provides an even bigger transactional database for manufacturing procurement.

    Consider James Richardson, owner of a two-person industrial-design firm in Weston, Connecticut. In 1998, he received a contract to design and build a running-in-place exercise machine. He set out to find manufacturers of membrane switches, essentially pressure-sensitive circuits printed on Mylar polyester film. Richardson first went to the Thomas Register Web site. Then he explored other sites on the Internet. He found dozens that listed products and described the companies that made them, their delivery schedules, and whether the products met international quality standards. Then he hunted up assemblers, who described their quality levels. Richardson produced a set of engineering drawings on his computer and e-mailed them to a list of prospective suppliers. A few weeks later, his chosen suppliers were mass-producing the exercise machine. Richardson had set up a virtual factory without leaving his office or investing any of his own money. He created a new business model by using internetworking to cut transaction costs.

    Adrian Slywotzky defines a business model as "the totality of how a company selects its customers, defines and differentiates its offerings (or response), defines the tasks it will perform itself and those it will outsource, configures its resources, goes to market, creates utility for customers, and captures profits. It is the entire system for delivering utility to customers and earning a profit from that activity." He points out that companies may offer products or they may offer technology, but these offerings are embedded in a comprehensive system of activities and relationships that represent the company's business design. Slywotzky emphasizes activities and relationships, both of which are changing dramatically.

    In this ever-changing tapestry, which thread should you grab first? Our research and experience suggest that you should begin with disaggregation—and its natural complement, reaggregation. Richardson's story shows that because the Net cuts transaction costs, a company can create value through a disaggregated business architecture. The challenge facing today's manager is to turn disaggregation from threat to opportunity.

    Webster's defines the verb disaggregate as "to separate into component parts," and reaggregate as "to cause to re-form into an aggregate or a whole." These themes apply both to the transformation of the value proposition and to the design of new organizational structures for enhanced value creation. In the digital economy, Coase's law goes into overdrive. On the one hand, the discrete value-creating activities of firms, even entire industries, become easier and cheaper to disaggregate out to the open market. On the other, the coordination tools of the digital infrastructure enable firms to expand massively in highly focused areas of competency. In this book, we describe how companies like eBay and Cisco Systems provide models for doing both these things simultaneously.

    Disaggregation enables entirely new kinds of value, from entirely new kinds of competitors. As a result, relegating digital technologies to nifty Web-site designs or superficial cost-saving initiatives are potentially fatal errors of an industrial-age mind-set. Disaggregation should begin with the end-customer's experience—the value proposition. It breaks out that experience—as well as the goods, services, resources, business processes, and organizational structures that make it possible—into a set of logical components. Effective strategists honestly face the many weaknesses inherent in industrial-age ways of doing things. They redesign, build upon, and reconfigure the components to radically transform the value proposition for the benefit of the end-customer. Planners must imagine how networked digital technologies enable them to add new forms of value every step of the way, to each component part. Then, they creatively reaggregate a new set of value offerings, goods, and services, as well as the enabling resources, structures, and processes.

    The Wall Street Journal, founded in 1889, spent its first century as an aggregated collection of content (news, listings, advertising), context (the physical newspaper), and infrastructure (printing, physical distribution), bundled into a single tightly integrated offering. With the arrival of the Internet, the Journal, working with partner companies and even readers, disaggregated these elements into separate component parts, and then reaggregated them into an entirely new value proposition. The old value proposition was a physical package of yesterday's news, delivered to your doorstep or newsstand. The new one is a twenty-four-hour customizable information service, increasingly available anywhere—at the point of need. Subscribers can use the online Wall Street Journal Interactive (WSJI) to track their personal stock portfolios, set up the "newspaper" to present the stories they care about the most, join online discussions, and access the Dow Jones Publications Library to research just about any business topic. For Internet time, the WSJI value proposition may not be quite up to snuff: Avid readers note that some "current" news stories are as much as twenty-four hours old (and more on weekends)!

    Disaggregated from its physical wrapper, the content is now available through a variety of electronic contexts, including the publication's own WSJI, and a variety of third parties like a Microsoft Web channel, the PalmPilot wireless network, and mobile phones. These services share an underlying delivery infrastructure—the Internet—but each enables a different shade of customer value. The Journal's own Web site posts the entire contents of the printed newspaper and much more, which the serious reader can customize. Microsoft and PalmPilot provide quick, though sometimes perforce superficial, news updates for desktop and mobile users, respectively. The Journal redefines and enhances its value proposition to meet a particular set of customer needs. A specific cast of players—not only Microsoft and Palm Computing, but also network companies like BellSouth—participates in the b-web that supports a specific distribution context. All collaborate and compete in the creation of value, with an eye to the changing needs and expectations of the digital end-customer.

    In the digital economy, the essence of the value proposition itself is destabilized. But so is the structure that enables the creation of value—the vertically integrated firm. The Wall Street Journal can no longer rely on its own printing presses and delivery trucks to mass-produce its daily information feed. To get the new, customized message out, it must now form partnerships with Microsoft, Palm Computing, and many others.

    The reaggregation of the value proposition leads companies to change in other important ways. The Journal adds content to the Web site that readers of the print edition never get to see. It learns how to present and customize this content for Internet users. Microsoft and Palm extend their mandates from technology to information services. While intensifying its focus on its core competencies, each company uses partners to broaden its range of customer attractions. This is the payoff of reaggregation for the digital economy.

POPULAR APPROACHES TO BUSINESS-MODEL INNOVATION

We present here a brief tangent to our main focus: popular approaches to business-model innovation that turned out to be forerunners of the b-web phenomenon.

    The first stage of innovation was the vertically integrated industrial-age corporation, with supply-driven command-control hierarchies, division of labor for mass production, lengthy planning cycles, and stable industry pecking orders. Henry Ford's company—the first archetypal industrial-age firm—didn't just build cars. It owned rubber plantations to produce raw materials for tires and marine fleets for shipping materials on the Great Lakes. Hearst didn't just print newspapers; it owned millions of acres of pulpwood forest. IBM's most profitable products during the Great Depression were cardboard punch cards, and the company built and sold clocks until well into the 1970s. Mania for diversification reached an absurd peak in the conglomerate craze of the 1970s, when companies like ITT Industries poured billions into building Rube Goldberg-like corporate contraptions that simply did not hang together.

    It took sixty years for the global business environment to converge with the potential implicit in Ronald Coase's insights. As the twentieth century unfolded, the accelerating progress of computer and communications technologies peeled back transaction costs at an ever-increasing rate. In the late 1970s, the vertically integrated mass-production manufacturing company went into crisis. North American companies had become dozy, fat, hierarchical, and bureaucratic in the twenty-five years after World War II. They gradually awoke to a U.S. defeat in Vietnam, an oil price shock instigated by a Middle Eastern cartel, and frightening competition from Japan and other Asian countries. Japanese manufacturers shook the ramparts of the industrial heartland—steel and automotive. Customers flocked to their innovative, reliable, and cheaper products. In 1955, American-owned companies built 100 percent of the cars sold in the United States. Thirty years later, their share had dropped below 70 percent. And other industries, from textiles to computers, felt the same heat.

    Managers responded with innovation in two business dimensions: process and structure. Process innovations included concepts like agile manufacturing, total quality, supply-chain management, and business process reengineering (BPR). These techniques helped fend off the challenges of offshore competition, cost, and customer dissatisfaction. They remain vitally important in their updated forms of today. But the techniques did not attack the core issues of value innovation and strategic flexibility. BPR's single-minded focus on cost cutting often led to forms of corporate anorexia that did more harm than good.

    Structural (business model) innovations were important forerunners of the b-web. Popular approaches to business model innovation included the virtual corporation, outsourcing, the concept of the business ecosystem, and the Japanese keiretsu.

    At the height of their crisis of self-confidence, North American managers and strategists stumbled across the keiretsu. It struck terror in their hearts. Keiretsu members in automotive, electronics, banking, and many other industries had suddenly emerged as global samurai. Rooted in centuries-old fighting clans, a keiretsu is a semipermanent phalanx of companies bound by interlocking ownership and directorates. Keiretsu battled aggressively with one another and on the international front, drawing strength from a strong us-versus-them mind-set. Keiretsu, along with cartels, were not just a strategic option for Japanese companies. They defined the business environment: The Japanese Fair Trade Commission estimated that over 90 percent of all domestic business transactions were "among parties involved in a long-standing relationship of some sort." The strength of keiretsu also proved to be their downfall. Their tight, permanent linkages—the very opposite of an agile business structure—help to explain Japan's economic difficulties during the latter half of the 1990s.

    Ironically, now that the keiretsu have been increasingly discredited in Japan, they have become fashionable in Silicon Valley as companies in all sectors discover the power of strategic partnering via the Internet. Proponents like the industry analyst Howard Anderson have not developed a new view of the keiretsu. Rather, they use the term as a pop epithet to describe partnerships ranging from loose associations to corporate conglomerates like AOL/Time Warner. In our view this application of the term is not helpful and obfuscates the much more important underlying dynamics of the business web.

    Though in part a response to the keiretsu, the North American virtual corporation was a fundamentally different idea. Proponents mystically described it as "almost edgeless, with permeable and constantly changing interfaces between company, supplier, and customers. Job responsibilities will regularly shift, as will lines of authority—even the very definition of employee will change as some customers and suppliers begin to spend more time in the company than will some of the firm's own workers." Other proponents depicted the virtual corporation as good, but elective, business medicine. But in Japan, keiretsu are like oxygen: Breathe them or die. Also, a virtual corporation is a temporary, opportunistic partnership: "Complementary resources existing in a number of cooperating companies are left in place, but are integrated to support a particular product effort for as long as it is economically justifiable to do so." Keiretsu relationships, on the other hand, are institutional and permanent. As we describe in this book, b-webs are, in one sense, more like keiretsu than virtual corporations. They are not merely good medicine, but part of the "air" of the digital economy. And a b-web—like the now twenty-year-old Microsoft software alliance—can go on for a very long time. However, unlike a keiretsu, a b-web is not necessarily a permanent arrangement, nor does it need to use ownership to integrate its participants.

    Outsourcing was a less ambitious idea than the virtual corporation: Pick a non-core activity and contract it out to a supplier who can do it more cheaply or better than you. Outsourcing is often a way to unload a problem function—like transportation or information technology. But outsourcing relationships can be tough. Outsourcer and outsourcee often perceive that they are in a zero-sum financial game, and they lack openness or trust. Such a mind-set characterized supply-chain relationships in the automotive industry for years.

    More fundamentally, in a world of b-webs, outsourcing is dead, not because big firms will take over all business functions, but rather the opposite. Managers will no longer view the integrated corporation as the starting point for assigning tasks and functions. Rather, they will begin with a customer value proposition and a blank slate for the production and delivery infrastructure. Through analysis, they will parcel out the elements of value creation and delivery to an optimal collection or b-web partners. The lead firm in a b-web will want to control core elements of its digital capital—like customer relationships, the choreography of value creation and management processes, and intellectual property. Depending on the particulars, partners can take care of everything else.

    None of these models—keiretsu, virtual corporation, or outsourcing—fully reflected how the world was changing by the mid-1990s. Then, with blazing insight, James Moore announced the business ecosystem, "an economic community supported by a foundation of interacting organizations and individuals—the organisms of the business world." The ecosystem includes customers, suppliers, lead producers, competitors, and other stakeholders, who "coevolve their capabilities and roles, and tend to align themselves with the directions set by one or more central companies."

    Moore's ecosystem metaphor illuminated the workings of the personal computer industry and others like it, in which many companies and individuals innovate, cooperate, and compete around a set of standards. Bill Gates, the Henry Ford of the information age, pioneered and popularized ecosystem management techniques that have become common principles for b-web leadership: Context is king. Ensure voluntary compliance with your rules. Facilitate independent innovation. Harness end-customers for value creation. Go for critical mass fast. Moore's ecosystem metaphor, though powerful, has limitations. It evokes a natural world in which biology and animal instinct rule, instead of human thought, judgment, and intentional actions. Animal instinct may be a big part of business life, but it does not explain everything.

    By the mid-1990s, only a handful of corporations had made genuine progress toward any of these popular approaches to business model innovation. Two factors stood in their way. For industrial-era firms, all these approaches required too much of a break from established management cultures. And even the most advanced information technologies of the time—client server computing and electronic data interchange (EDI)—reinforced a centralist, hub-and-spoke business architecture. These technological systems had to be custom built, and at great expense. The Internet's universal-knowledge utility did not yet exist.

    At this point in the mid-1990s, the sense of anticipation was nearly palpable. The worlds of business and communications were on the eve of revolutionary changes. It was as if the air had gradually become saturated with a combustible mix of gases; the tiniest spark would set off a vast explosion. The explosion came with the creation and discovery of the World Wide Web—a revolutionary new medium of human communications based on a few simple lines of software code. By the end of the decade, the Net was driving over $160 billion in transactions per year, most performed in and by b-webs.

WHAT IS A B-WEB?

If the corporation embodied capital in the industrial age, then the b-web does the same for the digital economy. In b-webs, internetworked, fluid—sometimes highly structured, sometimes amorphous—sets of contributors come together to create value for customers and wealth for their shareholders. In the most elegant of b-webs, each participant focuses on a limited set of core competencies, the things that it does best.

    Business webs are inventing new value propositions, transforming the rules of competition, and mobilizing people and resources to unprecedented levels of performance. Managers must master a new agenda for b-web strategy if they intend to win in the new economy.

    As stated earlier, a b-web is a distinct system of suppliers, distributors, commerce services providers, infrastructure providers, and customers that use the Internet for their primary business communications and transactions. Several b-webs may compete with one another for market share within an industry; for example, the MP3 b-web competes with the SDMI (Secure Digital Music Initiative) b-web launched by the Recording Industry Association of America (RIAA) in December 1998.

    Three primary structures of the b-web universe are internetworked enterprises, teams, and individuals; b-webs themselves; and the industry environment (figure 1-1). Internetworked enterprises, teams, and individuals are the fundamental components of b-web collaboration and competition. Typically, any single entity participates in several—sometimes competing—b-webs. Microsoft leads its own b-web and also participates, for better or worse, as a licensed developer in the competing Java b-web. Meanwhile, its fierce competitors, IBM and Oracle, contribute applications to Microsoft's b-web and (in IBM's case) sell Windows-compatible personal computers. An industry environment (e.g., the software industry) is a distinct space where several b-webs compete.

    How do you tell a b-web when you see one? Look for nine features, which are also key design dimensions for an effective and competitive b-web (table 1-1).

1. Internet infrastructure. The participants in a b-web capitalize on the Internet's ability to slash transaction costs, using it as their primary infrastructure for interpersonal communications and business transactions. If you scratch a business exchange on the Net, then you will likely find a b-web. Spot ways that the Net can cut transaction costs, and you'll find b-web opportunities.

2. Value proposition innovation. A b-web delivers a unique, new value proposition that renders obsolete the old way of doing things. MP3 doesn't just let fans play cheap tracks. It infinitely expands the music community, making tunes almost as easy to share as the printed word. B-webs deliver wildly diverse forms of value, ranging from liquidity in financial markets to restaurant supplies, computer operating systems, and X-Files fan clubs. End-customers don't always pay for these outputs. Often, third parties such as governments, advertisers, and volunteers subsidize the creation and delivery of customer value.

3. Multienterprise capability machine. Leaders of b-webs increasingly prefer a market model of partnership to the "internal monopoly" of a build-or-acquire model. Relying on b-web partners helps maximize return on invested capital. For example, in 1999 eBay facilitated $3 billion in auction sales via a $200 million technology and marketing system, with profit margins that exceeded Wal-Mart's. Traditional distributors like Sony sign artists to exclusive long-term deals; MP3.com's agreements are nonexclusive, and artists can end them at any time. While a traditional corporation defines its capabilities as its employees and the assets that it owns, a b-web marshals the contributions of many participating enterprises. The advantages—cost, speed, innovation, quality, and selection—typically outweigh the risks of partner opportunism. And it's much easier to switch from a nonperforming partner than it is to drop a weak internal business unit.

4. Five classes of participants. A typical b-web's structure includes five types, or classes, of value contributors:

• Customers, who not only receive but also contribute value to the b-web (e.g., MP3.com's music consumers).

• Context providers facilitate the interface between the customer and the b-web. A context provider leads the choreography, value realization, and rule-making activities of the system (e.g., the company MP3.com).

• Content providers design, make, and deliver the intrinsic forms of value—goods, services, or information—that satisfy customer needs (e.g., musicians who distribute through MP3.com).

• Commerce services providers enable the flow of business, including transactions and financial management, security and privacy, information and knowledge management, logistics and delivery, and regulatory services (e.g., Cinram International, which burns CDs for MP3.com on a just-in-time basis).

• Infrastructure providers deliver communications and computing, electronic and physical records, roads, buildings, offices, and the like (e.g., CERFnet and Exodus Communications host MP3.com's Web servers).

5. "Coopetition." Since participants cooperate and compete with one another, b-webs demand coopetition. Issuers of stocks, mutual funds, and other financial instruments have always cooperated by sharing press releases and other information, while competing for investor dollars. As financial markets shift to the Internet infrastructure, these processes accelerate and gain millions of new participants. Sometimes, as in the Wintel b-web, coopetition can be nasty. Its b-web participants, including the U.S. government, won a court case accusing Microsoft of using its control over the operating system context to deal itself unfair advantages in the applications content arena.

6. "Customer-centricity." Effective b-webs function as highly responsive customer-fulfillment networks. Instead of building goods and services to sit in warehouses in accordance with an inventory plan, they closely monitor and respond to individual customers—at the point of need. MP3.com has a tool that reviews customers' past selections and, based on their preferences, suggests other music that they might like. Members of a traditional supply chain, such as in the auto industry, tend to focus only on the next link to which they ship their products. Well-choreographed b-webs encourage all participants to focus on the end-customer: Cisco product assemblers Solectron and Celestica increasingly ship goods directly to consumers' homes. And, recognizing their own self-interest, these customers often willingly contribute knowledge value to such b-webs. Amazon devotees write book reviews and get virtual recommendations from other readers who share their reading preferences.

7. Context reigns. The context provider typically manages customer relationships and choreographs the value-creating activities of the entire system. By defining, piloting, and managing the context, a b-web leader gets the captain's share of the spoils. The company MP3.com, having branded itself with the name of the popular MP3 standard, has levered this advantage into a market leadership position. Within its own b-web, MP3.com defines the core value proposition and is lead manager of the customer relationship, the competitive strategy, the admission of participants, the rules of engagement, and the value exchanges. Other sources provide content and other services; MP3.com plays a limited role in defining the specific day-to-day details of the content that its customers see.

8. Rules and standards. Participants must know and adhere to the b-web's rules of engagement. Voluntary adherence to open standards and technologies minimizes dependence on the proprietary methods of individual b-web participants; the MP3 standard has attracted dozens of companies, including Amazon.com, Yahoo!, and America Online (AOL). Some rules can't just be voluntary. Stock markets have tough rules about disclosure and compliance; if you break some of these rules, the government might put you in jail. The context provider often originates rules and monitors compliance. But rules—and enforcement—can come from anywhere, including government, key customers, and suppliers.

9. Bathed in knowledge. Participants in a b-web use the Internet to exchange operational data, information, and knowledge instantaneously among all participants who "need to know"—sometimes in depth, other times to a limited degree. In addition to music, MP3.com offers personal playlist management, musician biographies and tour schedules (as well as links to their Web sites), industry news, message boards, online forums, and the preference-based selection tools mentioned above. Knowledge sharing is also important in a negative sense. In the baseline definition of a b-web, participants evidently share operational data, such as product information. But they do not necessarily share strategic or competitive information with one another.

B-WEB COROLLARIES

Everyone seems to agree that the new world of Internet commerce works differently. New modes of operation mean new rules, and several authors have offered up lists. Instead of rules, we would like to suggest corollaries of the b-web phenomenon: some obvious propositions, logical deductions and inferences, and natural consequences to consider as you ponder the implications of this new corporate form.

    We are in uncharted territory. Unlike the traditional industrial corporation, b-web structures and processes are highly malleable. Creative business-model architects like the leaders of MP3, Priceline, Linux, and Cisco have already seized on the b-web to create arrestingly new and competitive value propositions and organizational designs. In 1999, the MP3 phenomenon took another leap into the unknown when a company called Napster.com (quickly sued by the RIAA) launched a free service to let users seek and share tunes directly from one personal computer to another. Who knows where all this will end up? The first twenty years of the new century will be a golden age of business model innovation, which will set the course for decades to come.

    Exceptionally high returns on invested capital (the capital resources at a firm's disposal) can occur. A b-web requires less physical capital (stores, warehouses, and inventory) than do traditional firms, meaning lower fixed costs and higher operating margins. The b-web's leaders can leverage the capital assets of partners, but need to carry none of the associated liabilities. For such reasons, by our calculation, for several years Cisco's return on invested capital was about twice Nortel's. Moreover, firms in b-webs can exhibit exponential returns to scale where revenue growth is exponential, while costs grow at a modest linear rate. Amazon.com expects to increase revenues in new markets like toys and auctions by leveraging the relationship (brand, customers) capital and structural (business processes, technology) capital it amassed as an online bookseller. The company's high market capitalization of its early years assumed both high returns on invested capital and exponential returns to scale.

    Industrial-age businesses (like supermarkets) often put customers to work doing physical labor (like picking and delivering their own groceries). In b-webs, where customers mainly contribute information and knowledge, customers have more power than ever before. They have the power of choice, because a move to a new supplier is only a click away. They have the power of customization, as new technologies increase their expectations that vendor offerings will match their unique needs and tastes. They have power coming from near perfect information: If Tide stops washing whiter than white, everyone will find out faster than fast. And customers have collective power. MP3 illustrates how customers can go "out of control" and change the course of an industry. Customers gain both tangible (cost, quality) and intangible (information, control, relationships) benefits while themselves contributing ever more value to the b-webs in which they participate. All of this means that to attract and retain customers, sellers must build trustworthy, two-way relationships that deliver real value.

    Disaggregation leads to "disintermediation" and "reintermediation"—the elimination and replacement of physical-world agents and other intermediaries between producers and customers. New, low-cost, knowledge-value-enhanced intermediaries like MP3.com have placed music distributors under siege. But, for the time being at least, the old intermediaries will not simply fold up their tents and disappear. Rather than a single "killer app" intermediary in each space, we see a growing variety of intermediation models, each offering a distinct form of value added. To acquire music, you can go directly to the Sony site, an alternative like MP3.com, an online distributor like Amazon. com, or any of the traditional physical-world options. For a music publisher or musician, each of these intermediaries is an element of the b-web distribution channel mix. Each has a place, depending on the customer's situation and needs of the moment. So, although some individual intermediaries may be gasping for air, as a species, intermediaries are alive and well—in fact, busily mutating and multiplying. We (apologetically!) propose a neologism to describe this phenomenon: polymediation.

    The b-web poses a challenge to asset-based models of market control. As the world shifts from physical to digital distribution models, it is obvious that assets like music stores become less relevant to controlling markets. But big, capital-heavy assets are also losing clout in other, less obvious places. Sometimes, as in telecommunications, the pace of mergers and acquisitions camouflages this deeper industry challenge. The value and performance of a telecom company have traditionally depended on physical capital (wires and rights-of-way) and physical capital metrics (return on assets). With the emergence of wireless networking, such physical assets decline in relative value. A wireless network—whether for voice or data—can be cheaper to set up and run, and more flexible, than a wire-based one. Such networks will empower both customers and content providers with new kinds of flexibility and choice. Customers will be able to choose among a variety of competing service providers. Meanwhile, a galaxy of services, comparable to those on the Internet itself, will emerge for the new wireless communications infrastructure. Constellations of converging customer and content provider power will squeeze the economics of telecom even more. The result will be a competitive commodity market for mobile communications, in which network assets become less relevant than customer choice and value-added services. As we describe in chapter 6, this type of analysis applies to several other asset-oriented industries.

    Proponents of b-webs tout big ideas of business excellence as good medicine. Take a dose of the virtual corporation, process redesign, or knowledge management, and your company will feel better in the morning. Whether b-webs seem attractive or not, ignoring them is perilous. Unlike other big ideas, b-webs are inevitable. The MP3 b-web arose spontaneously, not because a manager read an illuminating book on business strategy. The b-web is emerging as the generic, universal platform for creating value and wealth. Like the corporation itself, the b-web concept is descriptive, not prescriptive; it will come in many different flavors, shapes, and sizes. Management practices—and everyday life—in a b-web will take many forms. Some b-webs will be wonderful places to work and do business, while others will be nasty and brutish. Some will succeed, others will fail. There is no single path to b-web success. Approaches that seem vitally important in most situations will be irrelevant, even counterproductive, in others.

    To paraphrase Mao Tse-tung, the b-web revolution is not a tea party! A b-web is a market space in which organizations both collaborate and compete with one another. The competition is often aggressive, sometimes wicked, and even unfair. Consider how Microsoft's treatment of its b-web partners landed it in court. At the same time, collaboration and partnerships are critical to the performance of most b-webs. Cooperation with competition—coopetition—is a b-web theme song.

    B-webs breed internetwork effects, a form of digital fusion among business entities. Physics describes how the fusion of hydrogen atoms releases energy. Under conditions of critical mass, a chain reaction occurs, with explosive results. Internetwork effects can display similar critical mass. MP3 experiments on the Net began in 1995-1996 and required vast amounts of energy just to keep moving. At a certain point in 1998, MP3 achieved critical mass of users and market momentum, took a quantum leap, and began to grow exponentially. In physics, fusion has a dark side—the release of terrible, destructive forces. Similarly in business, the internetwork effect blasts the bastions of the old economy.

DIGITAL CAPITAL

Former Citibank chairman Walter Wriston observed that information about money has become almost as important as money itself. Since this prophetic statement, new business models that deploy digital capital have wreaked havoc in the financial services industry, challenging the very existence of traditional banks, stockbrokers, and insurance companies. When intellectual capital moves to digital networks, it transforms entire industries and creates wealth in entirely new ways.

    Digital capital adds new dimensions to the three kinds of intellectual capital described by knowledge-management thinkers Leif Edvinsson and Hubert Saint-Onge: human, structural, and customer. One explanation for the high valuations of Internet stocks is the market's growing recognition of digital capital.

    Knowledge-management theory describes human capital as the sum of the capabilities of individuals in the enterprise. It consists of skills, knowledge, intellect, creativity, and know-how. It is the capability of individuals to create value for customers. The IBM stock of human capital includes the knowledge and experience of technology developers and consultants and the creativity and moxie they apply to innovation; the expertise of its sales people in closing deals; and the brain and determination of its CEO Lou Gerstner. A problem with human capital, as the saying goes, is that "it rides down the elevator every night." More than one IBM brain has made off to Hewlett-Packard, Sun, or a Silicon Valley start-up.

    The key shift in the digital economy is that the enterprise's human capital now extends to people across the b-webs in which it participates. MP3.com's human capital is internetworked. It includes the Net awareness and creativity of the 31,000 musicians who use it as a distribution channel; customers' willingness to set up their own "My MP3" home pages; and their involvement in personal playlist management, message boards, online forums, and preference-based selection tools. Sometimes, customers even participate in the design and creation of products. Users created the entire Linux operating system. The Java b-web depends on the design contributions of many different business partners and customers. When human capital becomes internetworked, participants share knowledge and commitments, dwarfing what was possible in the old economy. We describe the challenges and opportunities of choreographing internetworked human capital in chapter 7.

    Customer capital is the wealth contained in an organization's relationships with its customers and, according to most thinkers, its suppliers. It is IBM's brand equity, its depth (penetration) and breadth (coverage) in customer accounts, the trust of its customers, its deals with universities to seed IBM technology in the experience of future decision makers, the willingness of CIOs to share their plans with its sales force, and its customers' reluctance to switch suppliers. It also refers to relationships with Intel (which manufactures microprocessors for IBM personal computers), contract manufacturers that assemble its products, and software developers.

    When internetworked in your b-web, customer capital becomes relationship capital. In the digital world, customer capital intensifies into profoundly reciprocal linkages. It is also multidirectional, involving all b-web participants—customers and providers of context, content, commerce services, and infrastructure. Dynamic two-way relationships replace the concept of the brand as a one-way image that a vendor defines through print and broadcast media. Old marketing mind-sets become obsolete, as we describe in chapter 8.

    Structural capital consists of the codified knowledge and business processes that enable an enterprise to meet market requirements. Because structural capital does not reside in the minds of individual people, it helps mitigate the human capital brain drain. IBM's structural capital includes software development methodologies, project management tools, and development platforms for designers, analysts, and programmers. It includes sales management systems, product descriptions, training courses, and marketing databases. And it includes business processes for manufacturing, customer support, and myriad other functions.

    The digital extension of structural capital consists of, first, networked knowledge, processes, and tools available at the point of need and, second, new b-web business models that change the rules of market leadership. "MP3 shock," which combined networked knowledge, processes, and tools with new business models, quaked the industrial-age music business. Similarly, the Linux b-web ambushed Sun and Microsoft, mobilizing a volunteer army to create a new computer operating system that anyone can get for free. A major focus of this book is the transformation of structural capital that occurs in the digital economy.

B-WEB TAXONOMY

Not all b-webs are equal. We have investigated many hundreds and have written more than two hundred case studies. A number of distinct patterns emerged, with direct bearing on competitive strategy. Central to our analysis is a new typology of business models (figure 1-2).

    The typology applies to the physical business world almost as well as to the digital world. However, its digital application has some key differences.

    First, organizations often shift the basis of competition from one type to another as they move from the physical world to a b-web approach. A traditional full-service broker works (at least in theory) as a Value Chain, expertly tailoring advice to each individual investor. An online broker like Charles Schwab or E*Trade shifts the model to an Aggregation of advisory information and investment services, available to their customers for picking and choosing.

    Second, business model innovation becomes the basis of competitive advantage. Innovators like eBay, Cisco, and Priceline develop new ways to create and deliver value. In the process, they dramatically change the playing field and the rules of the game.

    Finally, in the physical world, one of the types of business models—the Alliance—is rare and primitive. In the world of b-webs, however, Alliances, including innovation collaboratives like Linux, become highly visible as powerful and dynamic drivers of change.

Dimensions of Differentiation: Control and Value Integration

Business webs differentiate along two primary dimensions: control (self-organizing or hierarchical) and value integration (low or high).

Economic control. In our analysis, control is about economics. Some b-webs are hierarchical; they have a leader who controls the content of the value proposition, the pricing, and the flow of transactions. General Motors designs and leads the integrated supply networks to produce preconceived products (e.g., the Cadillac Catera). Retailers like Amazon.com and Wal-Mart function hierarchically, taking responsibility for product selection, pricing, and customer satisfaction. Other b-webs self-organize. The market and its dynamics define the value and price of goods and services. Open-source software follows no management-imposed blueprint, because the product evolves through an organic development process open to all programmers. In stock exchanges and other types of auctions, the participants, not a single leader, drive content and price. Anyone can sell anything on an eBay auction (with the exception of prohibited items like weapons, animal parts, and other contraband!). Trading activity in the stock market continually responds to internal and external forces, whether a crisis of confidence in Asia, a speech by the chairman of the U.S. Federal Reserve, or a stampeding herd of institutional investors.

Value integration. Some b-webs focus on high value integration, that is, facilitating the production of specific product or service offerings (like cars, computers, consulting services) by integrating value contributions from multiple sources. We define value as the benefit that a user gains from a good or service. IBM achieves high value integration by taking contributions from many suppliers and turning them into a computer. Other b-webs focus on selection (low value integration); that is, providing a basket of choices rather than a single integrated solution. Ingram Micro, a leading wholesaler of computer hardware and software, does not alter the product offering. It focuses on distributing high-tech products, not making them. It currently offers products from more than 1,500 manufacturers. In between high and low value integration lie services like Instill, a restaurant industry supplier, which aggregates online catalogs from food producers, but also manages part of the restaurant supply chain, reducing inventory and minimizing stock outs.

Five Types of B-Webs

These two parameters—economic control and value integration—define the fundamental characteristics of five basic types of b-web: Agora, Aggregation, Value Chain, Alliance, and Distributive Network (table 1-2). As we describe later, each type also has subtypes. Agoras, for example, include open markets, sell-side auctions, buy-side auctions, and exchanges.

    Typically, a b-web is recognizable as a single, specific type. At the same time, as with most such models, every real-world b-web blends features of several types. Business design entails crafting a competitive b-web mix that draws on the many shades of this typology.

Agora. The agora of ancient Greece was originally the assembly of the people, convoked by the king or one of his nobles. The word then came to mean the place where assemblies gathered, and this place then evolved to become the city's center for public and especially commercial intercourse. We apply the term to markets where buyers and sellers meet to freely negotiate and assign value to goods (figure 1-3).

    An Agora facilitates exchange between buyers and sellers, who jointly "discover" a price through on-the-spot negotiations. Price discovery mechanisms in Agoras include one-to-one haggling, multiparty auctions, and exchanges. Examples include eBay, an Internet-based consumer auction, and Freemarkets, an innovative online business procurement site.

    Typically in an Agora, many participants can bring goods to market, or decide what the price should be. Because sellers may offer a wide and often unpredictable variety or quantity of goods, value integration is low. Internet Agoras offer significant benefits: many more sellers with a wider variety of products (benefiting buyers) and many more buyers to push prices up (benefiting sellers); convenience, low distribution and marketing costs, lots of information about all aspects of the deal; and entertainment—the thrill of the chase.

Aggregation. In an Aggregation b-web, one company—like Wal-Mart—leads in hierarchical fashion, positioning itself as a value-adding intermediary between producers and customers (figure 1-4). The lead aggregator takes responsibility for selecting products and services, targeting market segments, setting prices, and ensuring fulfillment. The aggregator typically sets prices and discount schedules in advance. An Aggregation offers a diverse variety of products and services, with zero to limited value integration. Retailers and wholesalers are prime examples of Aggregations.

    HomeAdvisor, Microsoft's Web context for home buying, not only offers half a million listings, but also provides real-time mortgage calculators, crime and school statistics, maps covering every U.S. metropolitan area, live e-mail updates, and loan qualification—all made possible through partnerships with b-web content providers. HomeAdvisor offers a total solution—from searching to financing—under one virtual roof. By bundling real estate information and services around a mortgage offering, it captures this profitable portion of the financial services industry away from banks and other lending institutions.

    E*Trade has aggregated many companies to create a virtual brokerage firm, charging one-tenth the fees of a traditional broker. Its dozens of content and service providers include stock quote services (Reuters, Quote.com), news (Reuters, PR Newswire, Businesswire), proprietary issuers (Robertson, Stephens), research (Briefing.com, InvesTools), market trends and projections (Baseline Financial Services), and personal financial tools (Quicken)—to name but a few. Internet delivery reduces customer costs; more important, customers gain intelligence that was formerly only visible to the high priests of the investment industry.

Value Chain. In a Value Chain, the context provider structures and directs a b-web network to produce a highly integrated value proposition (figure 1-5). The output meets a customer order or market opportunity—from an individual's buying of a Jeep with custom trim or Procter & Gamble's manufacturing of 20,000 case lots of Crest, to EDS's implementation of an electronic commerce infrastructure for one of its clients. The seller has the final say in pricing. It may be fixed (a tube of toothpaste), somewhat negotiable (the Jeep), or highly negotiable (the EDS deal).

    Cisco Systems makes networking products—such as routers—that shuffle data from one computer to another over the Internet or corporate computer networks. The company sits at the top of a $12 billion Web-enabled Value Chain. It reserves for itself the tasks of designing core technologies, coordinating processes across the b-web, marketing, and managing relationships. Other b-web participants do just about everything else, including most manufacturing, fulfillment, and on-site customer service.

Alliance. An Alliance, the most "ethereal" of b-webs, strives for high value integration without hierarchical control (figure 1-6). Its participants design goods or services, create knowledge, or simply produce dynamic, shared experiences. Alliances include online communities, research initiatives, games, and development communities like the PalmPilot and Open Source innovation initiatives. The MP3 phenomenon is an Alliance.

    Alliances typically depend on rules and standards that govern interaction, acceptable participant behavior, and the determination of value. Often, end-customers or users play a prominent role in value creation, as contributors to an online forum or as designers (e.g., of PalmPilot software or of the next piece of encoding in the Human Genome Project). Where products come from an Alliance, the end-customer often handles customizing and integrating the solution.

    Alliance b-webs often enjoy network effects. The more customers who buy PalmPilots, the more developers who decide to create applications. The value cycle is continuous and accelerating: As the value increases, usage mushrooms, and the applications market grows.

    Smart managers appreciate the power of Alliance b-webs. They willingly sacrifice some control over product evolution for the extra momentum that hundreds or even thousands of contributors can provide.

Distributive Network. The fifth type of b-web to have emerged from our research thus far is the Distributive Network (figure 1-7). These are the b-webs that keep the economy alive and mobile.

    In addition to the roads, postal services, telephone companies, and electrical power grid of the industrial economy, Distributive Networks include data network operators, the new logistics companies, and banks. These networks play a vital role in ensuring the healthy balance of the systems that they support. Like the human blood system, Distributive Networks neither create nor consume their essential cargo. But when these services fail, their host systems can die. And when a Distributive Network clots, its host can turn severely ill.

    Distributive Networks, in their purest forms (which is not always how you find them), service the other types of b-webs by allocating and delivering goods—whether information, objects, money, or resources—from providers to users. Along with Alliances, Distributive Networks often evince network effects: The more customers who use a Distributive Network (e.g., a telephone network), the more value it provides to all its customers.

    In relation to our two axes of b-web analysis—value integration and nature of control—Distributive Networks are "pure" hybrids. Their value integration is both high and low. It is high, because Distributive Networks must vouchsafe the integrity of their delivery systems, often a critical performance metric, for example, in a bank or a courier company. The value integration of Distributive Networks is also low, because their outputs can be diverse and unpredictable; from one day to the next, you can't foresee with certainty the pattern flow of cash through the banking system, or the flow of packages through UPS. Control of a Distributive Network's value is both hierarchical (tight network management is critical) and self-organizing (the continuous fluctuation of supply and demand determines value and price, as in electrical power and financial capital systems).

    In the following chapters, we present business model innovation strategies for the five types of b-webs: Agoras, Aggregations, Value Chains, Alliances, and Distributive Networks.