Since at least the 1980s, companies have embarked on digital transformations by coordinating, automating and outsourcing productive activity. Client-server architectures have replaced mainframes, reshaping supply chains and promoting decentralization. Enterprise resource planning (ERP) and customer relationship management (CRM) systems have automated back office and front office processes. Transitions to the cloud and SaaS have changed the evolution of software and the economy of rental versus ownership. Machine learning and artificial intelligence uncover patterns that drive new products and services. During the Covid-19 pandemic, virtual interactions replaced physical interactions out of sheer necessity.
Some of these changes were as simple as the process conversion from analog to digital. In other cases, companies have changed the way they work or what they do.
Yet, in the midst of all this transformation, something new – and perhaps fundamental – has changed: where and how companies create value has changed. Increasingly, value creation comes from outside the company and not from within, and from external partners rather than internal employees. We call this new production model a âreverse businessâ, a change in organizational structure that affects not only technology but also the managerial governance that goes with it.
The most obvious examples of this trend are platform companies Google, Apple, Facebook, Amazon, and Microsoft. They succeeded in achieving economies of scale in income per employee that would put the hyperscalers of the 19th and early 20th centuries to shame. Facebook and Google do not create the posts or web pages they serve. Apple, Microsoft, and Google don’t write the vast majority of apps in their ecosystems. Alibaba and Amazon never buy or manufacture an even greater number of items than they sell. Small businesses, modeled on platforms, exhibit this same pattern. Sampling the Forbes Global 2000, the platform’s companies versus industry checks had much higher market values ââ($ 21,726 million vs. $ 8,243 million), much higher margins. (21% vs. 12%), but only half of the employees (9,872 vs. 19,000).
In the past, high revenues per employee were indicative of highly automated or capital-intensive operations such as refining, oil exploration, and chipmaking. Indeed, automation has allowed Vodafone to downsize to handle 3 million invoices per year from over 1,000 full-time employees to just 400. But this time around, the transformation is different. Reverse firms achieve a much higher market capitalization per employee not by automating or shifting labor to capital, but by coordinating the creation of external value.
The digital transformation to the highest value comes from the business reversal – that is, the shift from the value that the company alone creates to the value that it helps orchestrate. Cultivating a successful platform means providing the tools and the market to help partners grow. In contrast, incumbents typically use digital transformation to improve the efficiency of their current operations. New income projections generally focus on capturing value. Of course, digital transformation can and should support operational efficiency, and it often comes first, but it can’t end there. Digital investments must prepare the business to partner with users, developers, and marketers, at scale, with an emphasis on value creation, which is the foundation for business reversal. Unconstrained by the resources that only the business controls, reverse businesses leverage and orchestrate resources that others control.
How reverse businesses create value
The most compelling evidence in favor of digital transformation as a business reversal comes from a recent study of 179 companies that have adopted application programming interfaces (APIs). As an interface technology, APIs allow businesses to modularize their systems for easy replacement and upgrades. APIs also serve as an âauthorizationâ technology that grants outsiders carefully measured access to internal resources. These functions not only allow a business to quickly reconfigure systems in response to problems and opportunities, but also allow outsiders to rely on the company’s digital real estate. Researchers (including one of the authors) categorized companies by whether API users used them for internal capital adjustment, upgrades and opportunities the company pursued, or used APIs for external platform business models that allow developers and other partners to create their own improvements and opportunities.
The difference in results between these two approaches is striking. Measured in terms of increases in market capitalization, the gains for companies that have chosen the path of internal efficiency have not been conclusive. In contrast, companies that took the path of external platforms, turning into reverse businesses, experienced an average growth of 38% over sixteen years. The digital transformation of the latter kind has resulted in huge increases in value.
Reverse businesses rely heavily on the engagement of their external contributors. This strategy relies on partners that the company does not know, ideas for volunteering that the company does not have – a very different process from outsourcing, where the company knows what it wants and makes a contract. with the most famous supplier. For the firm reversal to work, others must join the ecosystem, otherwise it’s about as helpful as having a potluck where no one is coming. Good management is what allows you to respond and invite your guests to create good things to share. How new guests are rewarded, the resources assigned to them, and the company’s willingness to help create that value can determine whether previously unknown partners choose to add value. It requires a different management mindset, from control to empowerment, and capture to reward. The more a company can convince its partners to make voluntary investments, ideas and efforts, the more this external ecosystem thrives.
To attract partners, these reverse firms follow a simple rule: âCreate more value than you take. A little thought shows the power of the ruler. People volunteer to invest in time, ideas, resources, and market expansion when they get value in return. Partners flock to a business that makes them more valuable, which in turn helps the business ecosystem flourish. In contrast, a business that gains more value than it creates scares people away. Why should they cook in a kitchen where the chef keeps all the sales or rely on digital real estate where the owner takes all the rent? Such ecosystems wither.
Good platform management means taking no more than 30% of the value and it can be a lot less. Too many product companies start with the bad habit of asking ‘How do we make money’ when they should instead start by asking ‘How do we create value? “And” How do we help others create value? âIt is only by creating value that one has the right to earn money.
New rules for value creation
Firm value used to be tied to tangible assets, but this is no longer the case. Intellectual property valuation firm Oceantomo has documented a 30-year trend of shifting company values ââfrom tangible to intangible assets. As of their 2020 accounting, intangibles made up 90% of the valuation of companies in the S&P 500. Of course, intangibles cover a wide range of things, including brand value, intellectual property, and goodwill. These strengths, however, were known long before the 1980s.
Among reverse businesses, the network effects that arise when partners create value for each other are a major source of intangible asset growth. Adding the ability to coordinate value creation and exchange – user-to-user, partner-to-partner, and partner-to-user – is one of the ways that traditional businesses are transforming. It also provides the means to evolve. Transforming atoms into bits improves margins and range. The transformation from the inside to the outside amplifies ideas and resources.
Of course, firm reversal involves risks of outside interference and negligence on the part of the partner. If partners are part of the value proposition, then a brand can suffer when that proposition fails. A family member of a co-author rented a host’s house on Airbnb only to find it had neither a shower nor a bathroom, a fact carefully omitted from the service description. Airbnb quickly intervened to discipline the host and offer the tenant more pleasant and free accommodation. Relying on third-party producers also implies having a high quality of curation of partners’ offers and a rapid ability to swap your own offer or that of another partner. Additionally, those who expose their data and systems to third parties may face an increased risk of a cyber attack. It means taking responsibility and being a good steward of others’ data. Getting data means giving back value and protecting those who share it. Overall, companies that understand and mitigate these risks significantly outperform companies that stay closed and avoid ups and downs.
The creation of the reverse business has a number of important implications. Most importantly, there are likely several gaps in an organization’s skill set for orchestrating third-party value. Adopting digital technology alone will not transform an internal organizational structure into one that functions externally. Leaders should understand and undertake partner relationship management, partner data management, partner product management, platform governance, and platform strategy. They must learn to motivate people they don’t know to share ideas they don’t have. Companies as diverse as Barclays Bank, Nike, John Deere, Ambev, Siemens and Albertsons have listed 200,000 vacancies for these platform functions and to run their increasingly reverse businesses. Indeed, companies that only look inward will be the ones that fail to move upward.