Ecosystems for organisations

1 Introduction

The term ecosystem was first used in biology, where it means a community of animals, plants and micro-organisms, the non-living things around them, and their shared environment. Within a biological ecosystem resources such as food, energy and waste are constantly transferred between the members and their habitat, and members depend on one another in ways that are not always obvious.

New challengers can arrive and put existing members under pressure. A simple example is Britain’s squirrel population: introduced grey squirrels became widespread, while native red squirrels contracted to protected strongholds, particularly in Scotland, northern England and several islands.

Business ecosystems behave in a similar way: new challengers arrive and threaten established organisations. For example:

• Low-cost airlines challenge traditional carriers

• Internet calling and messaging services challenge traditional phone companies

• Ikea challenges traditional furniture stores

• Netflix and other streaming services challenge cinemas and traditional TV channels.

To survive, organisations need to be proactive and quick to adapt. They also need to forge and sustain mutually beneficial relationships with suppliers, logistics companies, outsourced manufacturers, customers, competitors, governments and universities. In biological terms a relationship that benefits both parties is symbiotic (specifically, it shows mutualism – both parties gain – rather than parasitism, where one partner is harmed). Business examples:

• Games console makers depend on game developers, and vice versa

• The car industry depends on a network of filling stations sustained by oil companies

• The pharmaceutical industry uses university research findings in exchange for research grants.

In the early 1990s James F Moore began applying the term to business. His definition of a business ecosystem contains four important ideas:

• It is an economic community of interacting organisations and individuals that produces goods and services of value to customers

• Customers are themselves members of the ecosystem, alongside suppliers, producers, competitors and other stakeholders

• Members co-evolve their capabilities and roles over time – what one member does shapes what the others can do

• Members tend to align themselves with the direction set by one or more central (leading) companies. The leadership role is valued because it gives the community a shared vision to invest around – and the leader can change over time.

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2 Participants in a business ecosystem

Moore pictured the ecosystem as a set of layers, like an onion:

Core business layer: the heart of the business – suppliers, core contributors (often the organisation’s own employees, for example manufacturing staff) and distribution channels, together with the customers it serves directly. Some organisations perform all these functions themselves; others rely on a network of several companies.

Extended enterprise: widens the picture to include customers’ customers, the extended supply chain (suppliers’ suppliers), makers of complementary products and standards bodies.

Business ecosystem: the outside layer – government, regulators, investors, lenders, competitors, universities, trade unions, the local community and the world economy. These entities usually have no contractual relationship with the business and do not affect it day to day, but they can have very material effects: a government might rule that a product is dangerous and must be discontinued; the world economy could move swiftly into recession; a competitor could make a major technical advance.

Two familiar models between them cover most elements of an ecosystem – the markets and competition it operates in, and the society and regulation that surround it.

2.1 The macro-environment: PESTEL

PESTEL describes the macro-influences that bear on every ecosystem – society, regulation and the wider environment:

• Political – trading blocs, political stability, government attitudes to spending and to particular industries

• Economic – interest rates, exchange rates, boom or recession

• Social – changes in habits, preferences and population structure

• Technological – the internet and mobile devices have profoundly reshaped the ecosystems of banks, music companies and retailers; social media affects almost everyone

• Ecological/environmental – climate change, sustainability, recycling and carbon-neutrality expectations

• Legal – health and safety, consumer protection, and rules about what may be sold and how.

2.2 The industry layer: Porter’s five forces

Porter’s five forces look at the nearer, industry-level influences – the markets and competition element of the ecosystem:

• Competitive rivalry – are there a few large, powerful competitors or many weaker ones?

• Suppliers – a monopoly supplier is usually bad news; like an animal with a single food source, an organisation reliant on one input is vulnerable

• Customers – heavy reliance on one customer leaves the organisation exposed if that customer changes its mind

• Potential new entrants – newcomers usually arrive with a fanfare of special offers; incumbents want barriers to entry

• Substitutes – a substitute product can arrive suddenly and pull the rug from under the whole industry.

3 Ecosystems v networks and clusters

Before ‘ecosystem’ became the fashionable term, much the same set of relationships would have been called a network or a cluster: suppliers, logistics companies, distributors and designers all operating within a PESTEL environment, exchanging information, co-operating, competing and lobbying. The CGMA syllabus, however, treats the ecosystem as a genuine advance, and three ideas do give the concept extra substance:

• Sustainability. A biological ecosystem consists of living (biotic) factors and non-living (abiotic) factors, and it survives, supports itself and prospers without outside help – it meets its current needs without depleting the resources it will need in the future. A healthy business ecosystem should do the same: if members extract more value than the system creates, its life is limited.

• Self-governance. Biological systems self-regulate – ‘the balance of nature’. If grassland is over-grazed, herbivores perish and the grassland recovers. There is a feedback loop, and business ecosystems show the same behaviour: a company that treats a unique supplier so harshly that the supplier fails soon suffers itself. A properly functioning ecosystem permits controls to emerge – we return to this under rules and governance below.

• Evolution and adaptation. Biological evolution proceeds by random experiment – abandoning failures and adopting successes. Business evolution should be more rational, but it remains risky and essential: the market is changing, and doing nothing means extinction. Gathering data, market surveys and feasibility studies indicate changes that might work; the changes are then attempted, with no guarantee of success. An element of experimentation, chance and good fortune is present in every attempted change.

These three ideas are the interactions and dynamics of an ecosystem: members continually exchange resources and information, respond to one another’s behaviour through feedback loops, and co-evolve. An ecosystem is never static – the questions to ask are whether it is sustainable, how it regulates itself, and how it is changing.

4 Technology in ecosystems

Technology is the connective tissue of modern ecosystems. Digital platforms, cloud computing, mobile devices and shared data make it possible for large numbers of independent organisations to co-ordinate their activities without owning each other and without armies of intermediaries:

• Connection at scale – a smartphone app store connects one platform owner, millions of independent developers and billions of users; none of this is feasible on paper

• Lower transaction costs – finding a counterparty, agreeing terms and paying can be automated, so it becomes economic to deal with thousands of small partners

• Shared data – ecosystem members can share designs, forecasts, orders and performance data in real time, allowing tight co-ordination across company boundaries

• New interactions – technology creates roles and relationships that did not previously exist, such as accommodation platforms matching millions of hosts and guests.

Technology is also the great destabiliser: a technical advance anywhere in the ecosystem can change every member’s prospects, as we see later under disruption.

5 Rules and governance in ecosystems

No ecosystem works without rules. Some are imposed from outside; some emerge from within:

• External regulation – laws and regulators (national and local) set boundaries: safety, employment, competition and consumer-protection law all apply to ecosystem members just as to standalone firms

• Self-regulation – ecosystems generate their own controls. Rating and review systems let participants police each other’s behaviour; standards bodies agree common technical rules so that members’ products work together

• Leader-set rules – the central company often writes the ecosystem’s rulebook: an app store owner decides what developers may publish and what commission they pay; a marketplace decides who may sell and how disputes are settled.

Some writers (for example Gillian Hadfield) argue that traditional country-based law cannot keep up with fast-evolving, multi-company enterprises, and suggest globally agreed, outcome-based rules, with detailed regulation outsourced to specialist non-government regulators – rather as the World Trade Organisation sets economic ground rules. Corporate governance already works this way in many countries: an international body or national regulator announces high-level principles, a detailed national code is written, and compliance is effectively enforced through stock-exchange listing rules.

6 Risks and opportunities of ecosystem membership

Joining or building an ecosystem is a strategic choice, and it cuts both ways:

An organisation should therefore be deliberate about which ecosystems it joins, what role it plays (leader or contributor), how dependent it allows itself to become, and what share of the ecosystem’s value it can realistically capture.

7 Business models and value

7.1 Business models

A business model describes how an organisation creates and delivers value, then captures value back from its customers or clients – and how it generates or preserves value over the longer term.

It starts with a value proposition: what benefit do customers get if they buy this product or service? Airlines deliver quick, safe transport over long distances; internet service providers deliver access to the web; a fashion company delivers warmth and decency but might also deliver feelings of luxury and status. Value is created when customers’ needs are met – so deriving a value proposition means understanding what customers need and want. Do they have a problem to be solved (a pharmaceutical company addresses disease), or do they simply want a product or service (an orchestra delivers music)?

The product or service must then be created. A manufacturer could design a product and sub-contract production, or carry out the whole operation itself; a bank can run services in-house or use call centres. There is an almost infinite number of patterns, usually drawing on other members of the business ecosystem.

Finally the goods or services are sold and delivered through channels, which also play a part in communication. Clothes can be sold directly by manufacturers, through retail outlets, or via online retailers; technology has opened many new channels (websites, email, social media). Customers form different market segments, and what is delivered to each segment may need tailoring: furniture makers have different ranges for domestic and business customers; food manufacturers package ingredients differently for supermarket shoppers and caterers.

Value is captured back from customers via revenue streams when they pay. Customers do not care about the producer’s costs: they judge what the product or service is worth to them (often by comparison with competing offers), and that amount must cover the costs of everyone involved in delivery and still leave each participant some profit.

The elements fit together in the business model canvas:

The left-hand side is the activity perspective: activities are carried on in-house or by key partners, and they use resources. This side is where costs are incurred. The right-hand side is the customer perspective: the value proposition is delivered by building customer relationships and choosing delivery channels that reach each chosen customer segment. This side produces the revenue streams, and the difference between the two sides is the financial result.

To create anything of value an organisation needs the right capabilities, which consist of:

• Resources – raw materials, money, machinery, patents, people, management and brand strength

• Competences – the ability to use those resources to create something of value. Competences equate to the processes in the canvas: a process is a sequence of activities (quality control, for example, consists of reviewing designs, inspecting material and testing output). They include employees’ skills but also the organisation’s success at building links with suppliers, sub-contractors and customers.

Resources without competences achieve nothing. Sometimes outside partners have greater capabilities – and that is when that part of the process should be outsourced.

In summary, a business model does four things:

1. Defining value – understanding customers and framing the value proposition

2. Creating value – using resources, processes, activities, people and partners to create the offer

3. Delivering value – reaching each customer segment through relationships, channels and platforms

4. Capturing and sharing value – collecting revenue that exceeds cost, and distributing the surplus among stakeholders.

7.2 Platforms and network effects

Most traditional business models are linear (sometimes called ‘pipeline’ models): the firm buys inputs, adds value through its own activities and sells outputs – value flows one way down a pipe. A platform business model is different: the firm’s product is a marketplace that lets two or more distinct groups find each other and transact. Airbnb owns no rooms and Uber owns no taxis; eBay holds no inventory. Each creates value by matching one side of its market (hosts, drivers, sellers) with the other (guests, riders, buyers), and captures value by taking a commission or fee on each transaction.

Because a platform serves two or more groups at once, these are called multi-sided markets, and their economics are dominated by network effects – the offering becomes more valuable as more people use it:

• Direct network effects – more users of the same kind make the service better for each other (every new phone or messaging user makes the network more useful to every existing user)

• Indirect network effects – more users on one side attract users on the other side (more hosts make Airbnb more attractive to guests, which attracts more hosts; more app developers attract phone buyers, and vice versa).

Network effects have three practical consequences:

• Winner-takes-most markets – once a platform is clearly the biggest, both sides gravitate towards it, so a few platforms tend to dominate

• The chicken-and-egg problem – a new platform is worthless to each side until the other side shows up, so platforms often subsidise one side at first (free listings, sign-up bonuses) to get the flywheel turning

• Scale without assets – platforms grow by adding members, not factories, so they can scale far faster than linear businesses – but the value they capture depends on the members who actually supply the rooms, cars and goods, which is why platform commission rates and rules attract so much attention (and regulation).

7.3 Stakeholders

Stakeholders are anyone affected by the organisation. It is important to know who they are and what they want, because if stakeholders are unwilling to co-operate a strategy may prove impossible to implement – and, as we have seen, the business model exists to create value for stakeholders. All the main groups except competitors want value from the organisation:

(Competitors are stakeholders in the sense that they are affected by, and watch, the organisation – but they are not looking to receive value from it.)

The steps in analysing stakeholders are:

1. Identify the relevant stakeholders (typically customers, employees, shareholders and suppliers)

2. Prioritise and rank them, to understand which groups must be given most attention. Typically customers come first: if customers do not buy the product, no other stakeholder gets anything

3. Assess their needs. It is not always money: suppliers might prefer stable orders to high prices; employees might value training or conditions over a pay rise

4. Formulate the value proposition for each group – essentially, decide how the value created is shared out: wages, hours and conditions for employees; prices and reliability for suppliers; and the residue normally flowing to shareholders as dividends.

As value is shared out there is competition between the groups: higher wages generally mean lower profits and dividends. It is not always a zero-sum game, though – paying more and providing better conditions can attract more talented employees, who help the company earn larger long-term profits.

Stakeholders can be prioritised on the basis of power, legitimacy, interest and urgency:

• Power – can they impose their will on the organisation? Regulators have high power; so do skilled employees in short supply, through the threat of industrial action

• Legitimacy – would society regard the use of that power as respectable? Hospital doctors have great power, but striking would cost them legitimacy in the public’s eyes, which restrains its use

• Interest – are they likely to pursue their needs actively (high interest) or remain passive (low interest)?

• Urgency – does the claim require immediate action? Making a product safe after a series of accidents is urgent; an employee’s request for a secondment abroad can usually wait.

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8 Capturing and sharing value

8.1 Introduction

The selling price obtained from customers represents the flow of value into the organisation. If value has genuinely been created – by doing something customers value and cannot, or do not want to, do for themselves – revenue should exceed costs. The difference is profit, and the profit has to be shared among stakeholders.

CIMA suggests three things to consider when capturing value: the cost model, the revenue model and the distribution of the surplus. ‘Model’ makes this sound grander than it is – it simply means: understand what drives your costs, understand what drives your revenue, and decide who gets the difference.

Cost model

The organisation’s costs depend on:

• The efficiency of its processes – large-batch production achieves economies of scale, while high degrees of automation cut costs by allowing quick, efficient switching between small runs of different products, minimising idle time

• The level of activity – high volumes make better use of fixed costs

• Resources consumed – materials used efficiently cost less overall

• The cost of resources – negotiating good input prices keeps costs down. Note that the cheapest input is not always right: an organisation with a quality problem may deliberately raise its costs by buying better materials.

Revenue model

The organisation’s revenue depends on:

• Pricing policy – price to suit each market segment: relatively high prices for an affluent segment, lower prices for a price-sensitive segment where volume matters

• Channels and selling approach – direct or through retailers, single items or multi-buys, and how much advertising supports the selling effort

• Collection policy and terms – the gap between revenue (on an accruals basis) and the cash actually available.

Sharing residual value – sharing the profit

Four stakeholder groups are potentially involved in sharing the residual value:

• The government – through tax

• Shareholders – dividends, and share-price growth where profits are retained and reinvested

• Directors, managers and employees – profit-related pay and bonuses

• The company itself – profit retained and reinvested.

Who gets what is influenced by:

• Tax rates, and capital-allowance rates that encourage or discourage reinvestment

• Laws and regulations on profit distribution, including rules about distributable profits

• Industry norms

• Dividend policy – the ‘clientele effect’ suggests that investors such as pension funds choose companies that pay dependable dividends, so disturbing dividend policy is unpopular

• Reinvestment and expansion plans, and the desired capital structure (profits may be retained to repay loans)

• Contractual bonus arrangements with directors and employees.

9 Strategic drift and disruption

9.1 Strategic drift

Strategic drift occurs when the strategy of a business is no longer relevant to the external environment it faces. The process, and its consequences, run through four phases:

During incremental change the company keeps up with the environment and matches it fairly closely. Then strategic drift sets in: either the environment accelerates away and the company does not, or the company changes in an inappropriate way, and the gap widens. Flux occurs when the company recognises something is wrong and makes various adjustments, often in a state of panic. Finally the company either manages a radical move that catches up with the environment (transformation) or it fails (death).

Analysing the macro-environment can help a company identify – and perhaps anticipate – changes that will affect it. Ignoring those changes makes the strategy and business model steadily less successful. For example:

• Ignoring rising concern about pollution can damage reputation and invite government sanction

• Ignoring rising energy costs – and not exploring renewables – can leave the cost base higher than competitors’

• Ignoring changes in consumer tastes, or in the price of competing products, leads to falling sales.

Environmental analysis does not guarantee survival, because some major changes happen suddenly and unexpectedly. Those are not strategic drift – which implies a slow divergence – but disruption.

9.2 Disruption

Increasingly, an organisation’s environment and ecosystem can be described as VUCA: volatile (changing quickly), uncertain (we are not sure how it is changing), complex (the changes are hard to understand and may affect different sectors differently) and ambiguous (we are not even sure what is happening). Think of the travel industry, assailed by oil-price uncertainty, environmental concerns, political unrest and erratic economies.

Examples of disruptive technologies include:

• Artificial intelligence and machine learning – increasingly including generative AI

• Robotics

• RFID (radio-frequency identification) tags that allow individual inventory items to be tracked

• 3-D printing (additive manufacturing)

• Augmented reality.

Organisations can protect themselves against the VUCA factors – and build disruptive and resilient business models – in three ways:

• Be the disruptor – use innovation to become the cause of volatility rather than its victim. When Apple launched the iPod it quickly brought out the smaller mini, then launched the nano while the mini was still selling well, cannibalising its own sales to keep competitors permanently behind. This is self-disruption (see below)

• Create a safe space – insulate the organisation from adverse events: if competitors flood the market with cheap products, move up-market where competition is less fierce; if commodity prices are volatile, enter long-term contracts to bring certainty

• Build in resilience – keep cash or borrowing capacity available for hard times; negotiate break clauses in leases for flexibility; avoid over-reliance on any one supplier or customer.

Self-disruption

Self-disruption is an astonishingly difficult step, because it usually endangers current products and revenue streams and attempts to replace them with radically different offerings.

Around 2000, Microsoft was immensely successful in operating systems and business programs such as Word and Excel. Those products are still successful – but the focus on them meant the company largely failed to react to the disruption caused by the internet, streaming and mobile devices. Apple made those technologies a success, probably because it had nothing to lose by abandoning its small share of the existing technology. Similarly, it is instructive to watch which car companies successfully deal with the disruption caused by electric vehicles – rather than defending internal-combustion technology, however refined it has become.

There are five routes into self-disruption:

Build

The company creates the new product or service itself. Most feasible if:

• The new approach is related to the core business, so existing skills and knowledge carry over

• Time is on the company’s side – building implies delays and false starts

• The necessary skills, resources and talent can be acquired.

Buy

Take over an existing business. Suitable if:

• There is great urgency – a ready-made business model is acquired instantly

• The opportunity is unlike the current business – it is safer to buy the required resources and skills than to learn an alien set

• There is a need to own a substantial share of the market quickly.

Partner

Enter a joint venture with a company already in the new market. Suitable if:

• The company needs to learn, and to share risk and investment burdens

• There is no need to ‘own’ the market

• The company already has skills in managing alliances and joint ventures.

Invest

Put money into a young start-up, acting as a venture capitalist or business angel:

• For a relatively small outlay the established company gets access to the new technology or approach – and if the direction of the disruption is not yet clear, it can invest in several start-ups to spread the risk

• The start-up is kept at arm’s length, so its management stays flexible and nimble. There is little point investing in a company exploring a radical approach and then insisting it operate the old company’s way – the whole purpose is to learn and be ready for radical change.

Incubate/accelerate

Similar to investing, but hands-on rather than arm’s-length: the established company supplies skills the start-up lacks (marketing, say) or resources it needs (such as computing power) to accelerate its growth. This is sometimes called parental development: the investing ‘parent’ helps the ‘child’ become mature and successful.

10 Digital operating models

10.1 Introduction

An operating model describes the key relationships between the business functions, processes and structures that the organisation needs to fulfil its mission or purpose. Ryanair’s operating model, for example, is built around keeping costs low: it buys only one aircraft family (bulk discounts, interchangeable spares), often flies to cheaper airports and prefers customers to interact through its website. Other airlines run different models where cost is less dominant and fares and service standards are higher – suiting their market segments.

A digital operating model asks: how do we use digital technology to reconfigure those functions, processes and structures to improve performance and our chances of survival? Creating one is not simply ‘adding IT’: the organisation starts from its value proposition and customers, asks which processes technology could transform (or eliminate), and redesigns roles, structures and partner relationships around data and automation. CGMA identifies five types.

10.2 Five digital operating models

• Customer-centric – concentrates on making customers’ lives easier, emphasising convenient processes: ordering and paying at in-store touch screens, or a logistics company letting you track the delivery vehicle on a live map

• Extra-frugal (‘less is more’) – uses technology to standardise products and services and optimise ordering, production and delivery so they can be delivered at very low cost: Ryanair’s intense use of IT to analyse routes, load factors and fares, and to push check-in and boarding passes onto the customer

• Data-powered – builds the offer on data and analytics: Google’s advertising revenue rests on how well it answers search queries; app-only banks run everything online; Airbnb and eBay use data to match buyers with suppliers

• ‘Skynet’ – uses machines intensively to raise productivity and flexibility: Dell consolidating orders every hour and having components delivered straight onto the production line, eliminating raw-material inventory; Amazon’s highly automated warehouses

• Open and liquid – opens a constant two-way flow of information with the outside world and builds an ecosystem of employees, sub-contractors, partners and even crowd-sourced consumers around the customer: Boeing sharing designs electronically with a vast supplier network to bring the 787 to market; Rolls-Royce monitoring engines in flight so they can be serviced before a fault disrupts flights.

11 Test your knowledge

Two quick checks before you move on: run the flashcards to fix this chapter’s definitions and frameworks in mind, then attempt the ten objective questions to see whether you can apply them.