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November 12, 2001

Strategic Sharing

In a digitally connected world, vertical integration makes less and less sense

By Don Tapscott

The vertically integrated corporation is doomed as the basic vehicle for wealth creation in our economy. It's no longer the most efficient mechanism for marshalling economic forces.

As the comic strip Dilbert constantly reminds us, such corporations have always operated like clumsily planned economies rather than efficient marketplaces. Nevertheless, they prospered because they were better than any other model of production at the time. It was cheaper and simpler for companies to perform the maximum number of functions in-house, rather than incurring the high cost, hassle, and risk of constantly searching, contracting, understanding, collaborating, and executing transactions with outside partners.

Increasingly, the situation is changing. Thanks to the Internet, the costs of many kinds of transactions have been dramatically reduced, and sometimes approach zero. Large and diverse sets of people can now, easily and cheaply, gain near-realtime access to the information that will help them 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. Increasingly, specialists do a better value-adding job than 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.

The upshot is that a new business architecture is now challenging the industrial age, vertically integrated corporation as the basis for competitive strategy. I call it the business web, or b-web - any system of suppliers, distributors, service providers, infrastructure providers, and customers that uses the Internet as the basis for business communications and transactions. In the most successful b-webs, each constituent focuses on its core competence. In industry after industry, these new vehicles for value creation are proving more supple, cost-efficient, and innovative than their traditional competitors.

This competitive strategy is why established businesses such as Enron, Citigroup Inc., Herman Miller Inc., The Dow Chemical Co., American Airlines Inc., Nortel Networks, Charles Schwab & Co., and many product divisions of General Electric, are now transforming themselves by partnering in areas that were previously unthinkable. The CEO of The Boeing Co. says his company is a systems integrator, not an aircraft manufacturer. IBM is a computer company but doesn't make its computers - its partner network does.

Start-ups like Celestica, Flextronics Corp., and Solectron Corp. are partnering computer and telecommunications vendors to provide core electronics manufacturing services. The top five start-ups now have aggregate revenue of more than $50 billion, averaging return on invested capital of more than 25 percent - virtually overnight.

Moreover, the logic that motivates a Mercedes Benz to hire Magna International Inc. to build many of its cars is equally applicable to comparatively nickel-and-dime functions that companies perform on a day-to-day basis.

Dot-com start-ups such as eLance.com and Guru.com enable graphic designers, editors, translators, and even lawyers to peddle their wares to the world. The result is that independent contractors, rather than full-time employees in big companies, are performing more and more work.

In August, an eLance survey of businesses revealed that despite the sagging economy, more than 55 percent expected to boost their spending on outsourced projects. Only 6 percent expected to cut spending.

ELance helps buyers and sellers arrange for payment, provides online tools to help complete projects, and has a rating system that lets service providers build eLance reputations. More than 300,000 independent contractors from 150 countries now use eLance, and 40 percent of the transactions are cross-border. In May, juggernaut eBay partnered with eLance to offer its services to eBay's 30 million users.

Good To Reach Out

Smart companies appreciate that reaching out beyond corporate boundaries is much more effective than simply establishing corporate intranets. Intracorporate systems fail to capture the tonic of the marketplace.

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Most of what companies do isn't based on their core competencies. They attempt to build up and "make do" with design, manufacturing, marketing, and other capabilities that are often not best of breed in the open market. Moreover, insisting a project stay in-house often means it's comparatively more difficult to mobilize resources, even with a high-performance intranet. Employees are pressed into jobs unrelated to their skills, as managers are restricted to only the workers on hand. Alternately, adding new employees to the payroll is time-consuming and costly. Approvals must be sought, reporting structures developed, workspace arranged, and so on. Every manager knows these internal rigidities increase corporate costs and stifle innovation.

Marketplace disciplines are why the private sector has always proved more productive than the public sector. And it's these disciplines b-webs capture when compared to the bureaucratic infrastructures of vertically integrated corporations.

Don Tapscott [dtapscott@digital4sight.com] is president of New Paradigm Learning Corp. and coauthor of Digital Capital: Harnessing the Power of Business Webs (Harvard Business School Press, 2000).