The Stages of Corporate Organization
The configuration of the firm has progressed through three identifiable stages of increasing focus. The first large corporations were designed to achieve the necessary efficiency and size in order to produce a line of goods. By the 1960s, the diversified conglomerate built to spread risk was dominant throughout the developed world. By the 1980s, conglomerates shifted away from a strategy of unrelated diversification and stripped down toward more focused companies or integrated corporations. The third and current stage is characterized by a collection of multiple strategic business units within an integrated company. Most modern companies from IBM to Procter & Gamble fall into this category. The typical organization today has become narrower in breadth, yet still generally buys, makes, sells and distributes its products largely on its own.
Rewriting the Corporate Genome
However, the disruptive reduction in interaction costs caused by the Internet introduces a new discontinuity in our thinking about the shape of the corporation. We believe this disruptive change will thrust us into the next stage in the split-up of the corporation. Rather than organizing around integrated business units, a company will evolve around the underlying business capabilities. We define business capabilities as a set of value elements, built through knowledge, assets or processes, within the value chain that lead to a specific output.
It is time to rewrite the corporate genome. Our thesis is that the integrated corporation, often organized around strategic business units, has outlived its usefulness. Emerging in its place, we believe, are collections of separate businesses organized around the individual business capability--of which manufacturing, assembly and distribution, but also development, design and branding are all examples.
Driving this change is the true impact of the Internet. The Web liberates information-rich processes--by dissolving the strong link between product and information and making them less embedded in physical assets, such as plants and warehouses. Increasingly, business capabilities, such as manufacturing, development, design, assortment and branding are offered as stand-alone services or businesses. The erosion of the link between information and product can go so far as to create independent "businesses" out of the previously clustered business components.
Clearly, some industries have captured the lead in harnessing the power of information to rebuild their corporate genomes. Factors, such as the ratio between fixed and knowledge assets and the degree of deregulation and privatization in the industry, are instrumental in determining how fast companies are moving toward more modular organizations. The move toward a lower level of aggregation of the corporation--at the capability of a "gene" level--forces CEOs to set their corporations beneath a microscope. As capabilities are able to contribute more transparently to output, it forces a company to meaningfully address the questions of competition and the needed organization to rebuild their corporate genome.
Disaggregation of the Value Chain
The corporate genome maps what a company does, with whom it interacts and with what resources. If business capabilities become footloose, companies can create a separate business (or genome) around a single capability rather than a whole set. C.K. Prahalad introduced the concept of core competency. While C.K. Prahalad refers to competencies as the "collective learning in the organization," we define capabilities as any set of value elements within the value chain that make an unique contribution to output.
Now that the Internet has opened new sources of value for companies by liberating information flows from their physical envelope, the liberated capabilities can be analyzed on three distinct value chain levels: a physical flow, a transaction flow focusing on process and control and a knowledge flow that includes branding, design and assortment (Figure 3).
The ability to digitalize all sorts of information, as well as low-cost connectivity and the ubiquity of information on the Internet are responsible for separating information flows in businesses, whether related to knowledge or transactions, from the "physical process."
Finding News Sources of Competitive Advantage
As Clayton Christensen points out, competitive advantage is "predicated upon a particular set of conditions that exist at a particular point and for particular reasons."1 The breakdown of the value chain into capabilities has profound implications on competitive advantage. For one, the threat emerges of competitors, and not necessarily traditional rivals, surging for each capability. For innovators, the trend produces opportunities as well. Companies that grow by selling capabilities that excel as a separate business create new sources of competitive advantage.
The ability of individual capabilities to be seen as independent businesses is not by itself driving the shift in the source of competitive advantage. The real driver is the break from old business definitions that often harbor compromises inherent to the molding of different capabilities into one single business definition. The resulting opportunity cost of compromise is the underperformance of those capabilities that have been shaped in line with the leading capabilities. Doing away with such compromises for single capabilities--by driving a capability as an independent business--creates powerful sources of competitive advantage (Figure 4, pg. 20).
There are two ways to extract competitive advantage from individual business capabilities in the new corporate genome: by optimizing a single capability or by orchestrating a cluster of capabilities that lead to a single new specific and competitive output.
Competitive Advantage through Capability Optimizing
Some well established examples of capability optimization in the physical value chain already exist from contract manufacturing to logistics providers taking over parts of the supply chain. The physical value chain lends itself well to optimization because it is driven by the requirements of scale, flexibility and complexity. As a result, the impact of optimizing physical assets is easier to measure (and optimization more likely to be sought) than that of optimizing knowledge assets, which are often driven by such intangible factors as uniqueness or fit. In addition to this added transparency, products are also easier to value than knowledge assets.
The reduction in interaction costs enables companies to optimize the physical capabilities and address the increasing complexity of bringing goods to market. For instance, low-cost interaction can enable plants to handle different concurrent flows (for different customers) and to service to the complexity of individual products.
Efficiency in Knowledge Assets
While we can expect more elaborate optimization in the future, requirements introduced by the increased complexity of customer segmenting will make costs prohibitive for companies that do not optimize the value chain. The transaction flow has become more efficient as well because its drivers--scale and standardization--lend themselves relatively to optimization.
Optimizing knowledge assets, including development, design, branding and assortment management allows a company to charge a premium or increase market share as a source of value. However, optimization of these assets has been rather slow, and most companies do not realize value.
Efficiencies in knowledge assets work differently than physical and transaction assets. Rather than driven by scale, flexibility and complexity, knowledge capabilities are driven by such factors as effectiveness, time to market, fit and uniqueness. As these knowledge assets become increasingly footloose from their physical counterparts, they can more freely search for their own dimension of optimization. To accommodate the search for optimization, they will have to create exclusive networks outside their company boundaries to fuel new sources of competitiveness. It is the reduction in interaction costs that allows companies to organize for these virtual clusters, which would previously have been impossible to manage.
Competitive Advantage through Capability Recombination
Businesses can also create differentiating value by combining capabilities with other companies. Recombination of differentiating capabilities outside of company boundaries greatly enhances the value proposition and growth potential of the players involved. Such recombinations entail determining where the value lies in the goods or service cluster. Which is the differentiating gene that has the most impact on output? Sustainable value is achieved when the venture is difficult to replicate, differentiating it from what is already available and increasing switching costs. However, one must be attentive to changes in the competitive environment and wary of getting too comfortable in the integrator role. The value of a capability recombination can erode over time as new technology is adapted.
Although companies are free to decide whether to become the best in class in one capability or the best integrator of several capabilities, such business exhibits its own generic preference. There is huge value in becoming a Cisco-like orchestrator--if coordination happens to be an important capability in the company's output or, in other words, if coordination is the company's differentiating gene.
Reconsidering Business Definitions
The fact that traditional business output is now the result of capabilities has a profound impact on how we should define business segments. Rather than relying on dimensions, such as customers, geography and products, we also need to consider different combinations of required capabilities as sources of segmentation and drivers for business structures. If the competitiveness of a cluster lies in how it treats individual capabilities, then a business boundary will emerge where one capability trades place with another. This becomes especially relevant when the individual contributing capabilities have different owners.
What Does This Mean for the Corporate Organization?
The disruptive reduction in interaction costs lays the foundation for a future strategy that includes several possibilities. First, outsourcing can now be considered for a far wider range of business capabilities that was ever possible before. The reciprocal aspect of this is that companies can consider leveraging single capabilities at which they excel by selling them to help solidify their competitive advantage. They will then serve multiple markets. Perhaps most important, companies increasingly strive for competitive advantage by recombining parts of different companies in new and differentiating ventures. Fortunately, traditional strategy tools can still be applied in a company's efforts to compete at the capability level--Michael Porter's competitive advantage framework and C.K. Prahalad's core competency framework still apply--but at the capability level--rather than the strategic business level.
Second, organizing for change in the face of this disruption means bringing management focus from the business unit level down to the capability level. Shaping the new organization in this way involves taking steps toward allowing a company to behave as a set of multiple businesses. Enabling capabilities to be managed in their own right has profound implications for the company's resources, culture, organization structure and leadership; all need to become more capability-specific to match the change of scope. It also implies doing away with the matrix organization. Venture directors, the old business unit managers, will now buy services directly from the appropriate capability directors, who in turn, will most likely sell these services outside their company boundaries as well. Furthermore, the capability organization will sharpen capital effectiveness, and the new multi-capability corporation will likely build on myriad partnerships and various forms of supplier relationships that will become more complex to manage and will increasingly require new forms of goverance.
Johan C. Aurik is vice-president in the Brussels office of A.T. Kearney, and has more than 12 years of experience in resolving strategic and operational issues for North American and European companies. Gillis J. Jonk is a principal in the Amsterdam office and Robert E. Willen is a principal based in Boston at A.T. Kearney. The authors will be publishing a book on this subject in the fall. Contact: firstname.lastname@example.org.
1 Clayton M. Christensen, "The Past and Future of Competitive Advantage," MIT Sloan Review, Winter 2001.