Accenture Beyond These Castle Walls Three Strategies Open Firm

Beyond these Castle Walls: Three Strategies for the Open FirmBy Mark Purdy, Matthew Robinson, and Kuangyi Wei

Research report

July 2012

Beyond these Castle Walls: Three Strategies for the Open Firm

2 | Accenture Institute for High Performance | Copyright © 2012 Accenture. All rights reserved.

Companies used to have “borders” that were largely fixed and impermeable—customers and suppliers, for example, stood outside “the walls” while employees looked out upon them. Today that’s less and less true. Consumers now often “co-produce” innovations, suppliers are welcomed inside, and so on. While these changes often bring great benefits to companies, they also produce headaches for management caused by the surrender of control. In this report, we lay out three strategies for managing the risks and rewards brought about by this breach in the firm’s castle walls.

For well over a century, the firm has been viewed as an efficient mechanism for organizing capital, labor and other inputs into productive activities. Firms grew large because of the presence of economies of scale and scope, and because it was often easier to organize production within the borders of the company than to use the wider marketplace.

Recently, however, this traditional view of the firm has seemed increasingly at odds with the evidence of how firms actually operate in markets. Spurred on by a raft of new technologies such as cloud computing, social media, superfast broadband, wireless and remote mobility, the primary impulse in most markets today is toward greater openness.

In these more open business ecosystems, the borders between the firm and its stakeholders—customers, suppliers, workers, innovators, and so on—have become much more permeable and reconfigurable. New market mechanisms and intermediaries are arising as consumers discover new ways

to cluster together for the purposes of production, consumption, or innovation. The sharp distinction between “customer” and “producer,” for example, is increasingly eroded as consumers engage in forms of co-production, either with firms or other like-minded consumers. Innovation is shifting from the laboratory to the community, as firms draw on the creative capacities of the “crowd” to fire their innovation engines.

In short, the notion of the firm is evolving from that of an organization with relatively well-defined and insulated borders toward that of an interconnected enterprise defined by the porous nature of its external boundaries—something we term “the open firm.”

But openness can be overwhelming. With new configurations of capital and talent and unfamiliar sources of competition, many business leaders are exposed outside their comfort zone and fear the complexity of relationship management, attenuation of organizational control, hemorrhage of intellectual property, and even dilution of brand that these may be bring.

Businesses need to be able to maximize the benefits of openness while limiting the risks. This calls for strategies that are rooted in the new market reality. In the rest of the article, we will propose three strategies based on our research, experience and observation.

The harbor and fleet

One way in which firms are harnessing the benefits of openness is through a “harbor and fleet” model. In this model one firm—the harbor—provides a platform to which other firms become moored for mutual economic gain, much like a fleet of ships in a seaport. The services provided by the harbor company usually contain a large element of fixed and sunk costs—think IT networks, logistics and distribution, or supply-chain management—that would be expensive, if not impossible, for the fleet companies to provide independently.



Figure 1a: Economics of the harbor and fleet strategy

Figure 1b

Better utilization of excess capacity enables the harbor company to move down along the average cost curve and generate higher profits.

Access to infrastructures and business function standardization shifts down fleet companies’ average cost curve, making previously unattainable operations profitable.

The companies in the fleet—typically small or mid-sized companies—gain because their fixed costs are drastically reduced, thus enabling them to price at levels that cover their average costs and become economically viable. (See Figure 1b.) The harbor company, usually a large enterprise with significant excess capacity in the service or infrastructure provided, gains from lower costs associated with better use of its asset base and by capturing a portion of the revenue streams that flow over its platform. (See Figure 1a.)

Amazon is perhaps the pre-eminent exponent of a “harbor” model. Its success was founded on efficient warehouse management and procurement excellence. Having built a strong portal to reach its own consumers in the 1990s, Amazon realized it could extend that system to other businesses—becoming a harbor for a whole range of industries and sub-sectors. Because its profit margin has always been centered on its technical excellence (it could procure and deliver products better than its competitors), it did not matter to Amazon if it sold its own products or captured margins while helping other companies sell theirs.

However, harbors are springing up in other industries too. Consider healthcare, an industry that is being revolutionized through technological developments such as the digitization of patient information, health analytics and mobile and home-based delivery of healthcare. Such innovations have the potential to resolve the perennial problem besetting healthcare systems everywhere—how to improve health outcomes while keeping costs under control. Yet many smaller physician practices often struggle to afford such systems because of the large up-front costs.

Price / Cost

Price / Cost

Profit (before)

Fixed cost

Total cost

Average cost(before)

Average cost

Average cost(after)

Demand curve

Demand curve

0 QuantityThe harbor company

Fleet companies0 Quantity

Profit (after)

Profitable operation area



The demand forum

In 2008, at the height of the global downturn, two entrepreneurs—Vin Acanti and Jim Moran—spotted a market opportunity. In the recessionary climate of the time, collective buying sites were finding favor with cash-strapped consumers eager for a good bargain—such sites typically offered special deals on excess stock of a limited range of products, usually on a daily basis. Customers benefited from lower prices while suppliers found a welcome outlet for unsold inventories that had accumulated during the downturn.

Acanti and Moran thought they could take this concept a stage further—what if one could aggregate the deals on offer from a whole range of different collective buying sites to offer customers a much wider range of goods and services? The result was the creation of Yipit, a firm that bundles daily deals from around 130 other collective-buying sites such as GroupOn and Tippr, thus widening consumer choice

as well as extending the potential market for suppliers and other buying sites. Armed with a much larger customer base, Yipit acquired the ability to target deals to particular customer groups. It found that it could also amass significant insights into consumer behavior, using a mobile and web application, Foursquare, that tracks where consumers go—and, by extension, what they buy—thus providing real-time localized consumer insight and enabling significant scope economies in marketing.

Yipit is an example of our second model of openness, the “demand forum.” It can be thought of as a clearing house that brings together the buyers and sellers in a market for mutually beneficial exchanges. This type of strategy is aimed at improving demand revelation among potential customers, improving pricing power and profitability. (See Figure 2.)

Demand-forum strategies have been deployed in the nascent market for solar power in cities. With any new technology, it can be difficult to identify a critical

Athenahealth, a company that provides practice-management services for physicians, has harnessed a harbor strategy to overcome this difficulty. It has pioneered the use of cloud computing to replace paper-based medical record systems with a much faster and more efficient electronic system for the 23,000 healthcare providers in its network. Healthcare providers—the fleet—contribute a percentage of practice revenues to Athenahealth, creating a funding model that is linked to their long-term success.

The harbor model is also gaining ground in areas such as the management of global supply chains, particularly as businesses give greater attention to ethical sourcing and sustainability considerations in purchasing decisions. As global supply chains snake across the world, supply-chain monitoring and certification has become particularly onerous for smaller companies, creating significant fixed costs which can act as a barrier to market entry.

Historic Futures is a company that has created an infrastructure to overcome this problem, providing information on supply-chain traceability such as country-of-origin of products and sustainability features such as product miles and water usage for smaller companies. It has developed an online application called String, allowing users to trace products back along the supply chain. In effect, Historic Futures acts as a supply-chain referee, providing virtual infrastructure that allows smaller companies in its fleet to drastically reduce their fixed costs of supply chain monitoring and certification.

Figure 2: Economics of the demand forum

Greater market exposure shifts out a company’s demand curve, enabling revenue surge through expansion in demand and better prices for producers.

Price / CostSupply curve

Demand curve (after)

Demand curve (before)

0 QuantityExtra revenue from demand expansion



mass of early adopters and scale up the technology so that it becomes profitable quickly. One Block off the Grid (1BOG), a community-based program to promote solar energy, uses a demand forum model to get around this problem. Founded in 2008, 1BOG aggregates groups of homeowners in a city that want to use solar power. Signing up to 1BOG is free for the consumer; the company negotiates discounts with solar installers on behalf of consumers, and captures payments from solar installers in exchange for customer referrals and volume purchasing. Any city in the United States is currently eligible—all that is required is one hundred willing consumers.

Some demand forum strategies go a step further, actively bringing their community of users into the design of offerings and products. Take the example of Polyvore, founded in 2007 in Silicon Valley and billed as one of the web’s largest fashion communities, attracting 6.5 million individual users every month. Polyvore enables its users to create digital collages of clothing, accessories and lifestyle products from many different fashion retailers and brands. In one case of group creativity, consumers were given the opportunity to arrange Calvin Klein items into their own fashion sets. The benefit for firms that open up their boundaries to Polyvore is better demand revelation and consumer engagement with their brand: Polyvore users have created more than 20 million fashion sets to share with users on the company’s website and social networks.

Multivalent sourcing

A third open-firm strategy centers on economies of agglomeration in the supply of factors of production, whether materials, talent, innovation or capital. We term this strategy “multivalent sourcing,” reflecting the multiple bonds of connection that are formed with a variety of stakeholders. The benefits are twofold: enhanced bargaining power in input markets, and informational advantages in sourcing factors of production such as innovation and capital. (See Figure 3.) Let us consider these in turn:

Improved bargaining power: Consider Prime Advantage, a B2B company that offers group buying services to small and mid-sized industrial firms. By negotiating group-purchasing discounts with a number of different vendors, it provides its members with access to raw materials, components and business services at significantly lower rates than would otherwise be possible. Prime Advantage makes a profit via a subscription fee from members, while suppliers benefit from access to a larger demand pool of customers. The model also serves to enhance bargaining power in the sourcing of other inputs, such as employee benefits provision.

Many small and mid-sized companies are hamstrung in their efforts to attract the best talent because small scale makes it difficult to negotiate competitive benefits provision. SOI, a professional employer organization, runs an employee benefits pooling scheme grouping together hundreds of companies representing thousands of employees. By establishing partnerships with healthcare and financial service providers, it can create economies of scale and harness its collective buying power to negotiate better rates for member companies in areas such as health, retirement, and worker compensation provision.

Overcoming informational gaps: Most markets are characterized by informational deficiencies to some degree—the problem of connecting those who have goods, services, ideas, and capital with those who are in want of them, and co-ordinating that matching in an efficient way that yields competitive prices and low search costs. Supply-forum strategies are evolving as an efficient mechanism for overcoming such informational gaps and connecting firms to the wider marketplace of ideas, people and capital—the essential factors of production for any business.

Consider the problem of innovation: Here the fundamental challenge is how to connect those who have ideas with those, typically firms, that have the capital and infrastructure to convert those ideas into commercially viable goods, services, and business models. Open innovation models have taken root in industries such as pharmaceuticals, where rising costs and the expiry of intellectual property patents have propelled a search for more efficient ways of sourcing ideas and solutions to scientific problems. An early pioneer in the field was InnoCentive, the first global hub designed to help connect “seekers”—those with challenging research problems—and “solvers.”

Such crowd-sourcing of innovation is now evolving a stage further to encompass the concept of “elite sourcing,” using crowd sourcing to source ideas in a selective setting. Take the example of Edge Amsterdam, an organization that uses both electronic and off-line platforms to identify new talent in product development and brand innovation. In traditional crowd-sourcing, there is a significant risk of hit-and-miss due to the large pool of contributors. Edge Amsterdam selects talent exclusively from arts schools and



Figure 3: Economics of the multivalent sourcing strategy

Lower input prices and better access to corporate finance shift a company’s supply curve out, allowing it to gain extra revenue through supply expansion.

Better technology and higher quality talent enhance the marginal productivity of both labor and capital, making a company’s cost profile less volatile to market conditions.

Price / Cost

Price / Cost

Supply curve(before)

Supply curve(before)

Supply curve (after)

Supply curve (after)

Demand curve

Demand curve

0

0

Quantity

Quantity

Gain in revenue through supply expansion

Gain in revenue through supply expansion

Loss in revenue from supply expansion

Loss in revenue from supply expansion

other high-quality channels, thereby limiting the pool of contributors to those with known problem-solving qualities.

Napkin Labs, a consulting company that specializes in crowd-sourcing of innovation, utilizes the twin principles of selection and voting to harvest the best innovations from the wider ecosystem. It hand-picks a group of one hundred potential innovators for a particular project, both to ensure quality of ideas and keep the group manageable. New ideas and product concepts are then evaluated and voted on by the larger community, with Napkin Labs applying a set of algorithms to identify and reward the best innovations on the basis of criteria such as commercial influence and community spirit.

Multivalent sourcing strategies are not limited to innovation, but are also springing up in the sourcing of capital. Social networking platforms are increasingly used to connect would-be entrepreneurs with potential investors. One such example is GrowVC, a community-based social networking platform that brings together start-up companies with providers of seed capital, with the aim of raising $1 million for fledgling enterprises. Such strategies lower search costs for both investor and start-up, as well as increasing transparency for investors who otherwise would lack detailed information on the target of their investment.



Implications of the open firm models

In a multi-polar world where opportunities are increasingly dispersed across geographic locations, the need for businesses to excel beyond national borders will become more pressing than ever. For international business managers seeking to optimize their operations across diverse geographic locations, the open firm models elucidated in this paper bring important practical benefits, including the following:

Scaling across borders: Many small and medium-sized enterprises (SME) struggle to make the transition beyond the local or domestic market to regional or international markets. In Europe, for example, almost a quarter of European business leaders see a lack of export capacity as the most significant challenge to SME growth. By enabling SMEs to piggyback on costly infrastructural platforms (in relation to distribution or sales, for example) provided by bigger organizations, the harbor and fleet model can effectively lower barriers to new geographic market entry and mobilize elusive opportunities in unfamiliar localities. In addition, the harbor and fleet model also enhances standardization in logistical support, keeping supply-chain risks at bay for SMEs with limited logistical capacity.

Tapping into a bigger reservoir of regional or global demand: Social shopping is gaining prevalence in both advanced and emerging economies. In China, for example, there are currently more than 2,000 collective buying websites. With online consumption on the rise across the globe, the demand forum provides a mechanism to help businesses tap into this expanding reservoir of global purchasing power.

Achieving better market segmentation: By increasing the clout of consumers within market transactions, the demand forum enables finer consumer preference revelation and more efficient information gathering that reflects up-to-date market trends. This enables international managers to gain a more precise understanding of their consumers and conduct more efficient and timely product design in response to shifting consumer preferences.

Improving the quality, cost and availability of factors of production: As the world becomes more multi-polar, the distribution of productive resources—capital, talent, and ideas—is becoming increasingly diffuse across geographical borders. Multivalent sourcing offers a channel to tap into these dispersed resources and tailor them to the needs of individual businesses. By connecting to disparate and dispersed pockets of talent, capital and ideas across the world, firms can improve the quality and cost of these factors of production. A further merit of multivalent sourcing lies in its ability to improve supply-chain efficiency. Through targeted matching between suppliers and buyers, businesses can effectively avoid traps and waste in their regional or global supply chains.

The implementation of open-firm models, however, also entails several challenges, many of which stem from cultural, social, and regulatory differences across national borders. As detailed by Pankaj Ghemawat, professor at IESE Business School, many areas of economic activity remain essentially local in character, with a variety of social, cultural, and regulatory differences conspiring to create significant hurdles to cross-border integration. Recent history is replete with examples of overseas ventures that have foundered on such differences. Some of the common challenges include:

The quality and character of local networks: open-firm models are essentially network-based, so international managers need

to pay close to the nature and quality of networks in overseas markets. Is there a tradition of collective consumption or business co-operation through informal networks? Are these networks transferable to a virtual sphere? Are there deeply ingrained habits of consumption or production that are hard to change, such as a preference for physical transaction modes? Does the infrastructural capacity exist to create virtual networks? Is there a critical mass of users present to create deep markets for production, supply or consumption?

When facing complex and unfamiliar relationships that hinder the cross-border transfer of competencies, it is crucial for firms to create the right networks and identify key stakeholders. These include the suppliers that provide the inputs critical for the firm’s competitive advantage, the distributors that effectively link the firm with its target consumer groups, and the competitors with which potentially to enter alliances or joint ventures.

Complex patterns of local demand: when an open firm expands beyond national borders, the heterogeneity of consumer preferences and purchasing power can be more complex than in the firm’s home market. For example, on-line collective buying sites in the US and Europe typically cater to middle-class consumers in search of a bargain. In places like China, however, the typical middle-class on-line consumer is more likely to be in search of high-end products associated with status and prestige in society. The demographics may be similar, but the preferences are very different.

There are two strategies that can help open firms to overcome this unfamiliarity. The first is through more sophisticated customer groupings, using purchasing power and cultural background, rather than simply focusing on convention and



commonly used criteria such as geographic region or common languages. This can help firms to harness the power of the virtual community and more effectively tap into cross-border synergies.

The second is to adopt a “hybrid” approach by incorporating some level of physical presence. Having a physical presence is not only an effective way of gathering consumer information, improving data analytics and testing consumer preferences, it also helps to facilitate trust among unfamiliar consumers by “breaking the ice”. In addition, there can be significant synergies between virtual and physical presence in unfamiliar environments, particularly in areas such as marketing and distribution.

Business model replication: A somewhat more prosaic challenge for many open-firm models is the risk of business-model replication in local markets and loss of elements of intellectual property, particularly in jurisdictions where intellectual property provisions may be ambiguous or poorly enforced. A challenge facing collective-buying sites in some emerging markets has been the mushrooming of local versions which can often negotiate better deals with local suppliers. To overcome these obstacles, it is critical that firms constantly innovate to ensure that their business model is ahead of the curve. Open firms can also branch out into alliances or joint ventures with local competitors or start-ups to “add local flavor”.

Deciding which open-firm strategy works best for your business

As technological advances spur firms toward an era of greater openness, businesses will increasingly need to harness the economic benefits of virtual agglomeration. Based on our research, we have identified three types of open-firm models that effectively tap the power of virtual agglomeration. Not all of these strategies will be right for every firm: businesses will need to choose the best strategy based on characteristics such as their relative size, the nature of their industry, and their degree of comfort with ceding control. The summary framework set out in Table 1 can help business leaders decide which type of open-firm strategy—or mix of strategies—can work best for them. Some of the key questions for business leaders to consider in this decision include:

Have you clearly defined and protected your firm’s competitive essence? The quid pro quo of greater openness in some business functions is that a firm’s leaders must have an even tighter grasp of the things that make it unique—in other words, its competitive essence and the ideas, assets and capabilities that underlie it. What should be opened up to the ecosystem and what should be kept integral to the firm? What is really core intellectual property and how can it be protected in a more open system? The answers to these questions will be different for every firm depending on its industry, competitive positioning, and cultural traditions.

Have you built the right networks and do you have the skills to manage them? As highlighted above, the ability to locate, create and maintain appropriate networks is central to the success of open firm strategies. Open firms must manage complex webs of relationships with many different firms, customers, or input suppliers, with varying degrees of attachment to the core business. In such circumstances, firms pursuing open-firm strategies will need to put an increasing premium on relationship management skills, alongside more traditional “hard” technical or business skills, in their approaches to recruitment and staff development.

How will you maintain organizational identity and loyalty in more open ecosystems? As the borders of the open firm become increasingly permeable and connected to fluid ecosystems of people, firms and ideas, there is a risk that organizational identity and loyalty may become attenuated as the ties of common purpose loosen, at least initially. Core values will therefore become more important as the corporate “glue” binding employees and also, increasingly, ecosystem partners.



How do you manage reputation and brand in an era of fluid open-market relationships? Traditionally, firms sought to exert tight control over their brands. But with open-firm strategies, such control will be more difficult and possibly even counterproductive. Instead of working against the grain, firms can harness the power of virtual agglomeration to build and strengthen their brand. Engagement with customers and bloggers will be essential to prevent fast erosion of reputation when things go wrong. Firms can also look to mobilize the brand in non-traditional channels, reducing costs associated with traditional (and expensive) communication channels such as print and television, and creating greater share of voice.

How do you manage increasingly complex informational flows from a multitude of stakeholders? As firms engage with more open and diverse agglomerations of consumers, suppliers, producers, and innovators, the volume and complexity of information firms need to manage will mushroom rapidly. While partners in the ecosystem will be critical to helping firms manage such flows, organizations will need to retain the ability to sift and protect the most valuable and competitively important information. As businesses embrace advanced analytics, they will need to avoid becoming entirely dependent on others for mission-critical insight.

Table 1: Overview of open firm strategies

Model Function Economic benefits Complexity of Ceding of Duration International relationship control implications management

The harbor and fleet

The demand forum

Multivalent sourcing

Making services with a large fixed-cost component feasible through better utilization of excess capacity in infrastructure or other critical services Creating access to a bigger and better demand platform

Providing better access—in terms of cost, quality, or location—to factors of production such as talent, capital or knowledge

• Reductionin average cost • Increaseinservice standardization • Accelerationin asset turnover

• Increasein market exposure • Improvementin demand revelation • Qualitycertification and reputation building • Accessto specific talent • Innovationcreation and knowledge diffusion • Collective bargaining power • Accessto corporate finance

Low

High

High

High

Low

Low

Medium to long term

Episodic

Episodic

• Greaterease of geographic market entry • Greatercertainty in supply-chain management • Improvementin risk profile • Expansionindemand • Refinedmarket segmentation • Moreefficient and timely product design in line with local market preferences • Enhanced organization of dispersed resources— talent, capital, and ideas • Greaterconnection with local networks (in relation to R&D, venture capital etc.) • Improvement in supply-chain efficiency



As the open firm replaces the company-as-castle, executives will need to manage the trade-offs that come with diminished control over operations, customers, intellectual property and more. But when those trade-offs are executed within a conscious open-firm strategy, the rewards can far outweigh the risks.

About the authors

Mark Purdy ([email protected]) is a senior executive research fellow and the chief economist with the Accenture Institute for High Performance in London.

Matthew C. Robinson (matthew.c.robinson@ accenture.com) is a senior executive research fellow and leads the global trends research for the Accenture Institute for High Performance; he is based in London.

Kuangyi Wei ([email protected]) is an associate with the Accenture Institute for High Performance; she is based in London.

About Accenture

Accenture is a global management consulting, technology services and outsourcing company, with more than 249,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$25.5 billion for the fiscal year ended August 31, 2011. Its home page is www.accenture.com.

About the Accenture Institute

for High Performance

The Accenture Institute for High Performance creates strategic insights into key management issues and macroeconomic and political trends through original research and analysis. Its management researchers combine world-class reputations with Accenture’s extensive consulting, technology and outsourcing experience to conduct innovative research and analysis into how organizations become and remain high-performance businesses.



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Accenture Beyond These Castle Walls Three Strategies Open Firm