How to transform into open firm

2013-09-01 13:36

How to transform into open firm

By Kim Min-su
For well over a century, the firm has been viewed as an efficient mechanism for organizing inputs such as capital and labor into productive activities. Firms grew large because 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 changed with the evidence of how firms actually operate in markets. Spurred on by a raft of new technologies such as cloud computing, social media, 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, and innovators — 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. Luckily, there are three strategies which a company can turn to.

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, such as IT networks, logistics and distribution, or supply-chain management, that would be expensive for the fleet companies to provide independently.

Small or mid-sized companies in the fleet gain because their fixed costs are drastically reduced, thus enabling them to price at levels that cover their average costs and become economically viable.

The harbor company 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.

Harbors are springing up in many different industries. 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.

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.

The demand forum

The second model of openness, the “demand forum,” is a type of strategy that aims at improving demand revelation among potential customers, improving pricing power and profitability.

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 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 promoting 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 100 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.

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.

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 fledging enterprises.

Such strategies lower search costs for investor and start-up, as well as increasing transparency for investors who otherwise would lack detailed information on the target of their investment.

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.

In order to make the right decision, business leaders need to consider whether they have clearly defined and protected their firm’s competitive essence.

They need to identify what should be opened up to the ecosystem and what should be kept integral to the firm before deciding which model to implement.

Another important question to be considered is whether a company has built the right networks and obtained the skills to manage them.

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.

Under such circumstances, firms pursuing open-firm strategies will need to put an increasing premium on relationship management skills.

Top management also needs to consider how they will maintain organizational identity and loyalty in more open ecosystem and manage brand reputation.

Lastly, before adopting a new strategy for an open firm, a company should understand how it will 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.

As business embrace advanced analytics, they will need to avoid becoming entirely dependent on others for business-related insights.
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.

Kim Min-su is a senior manager at Accenture Korea.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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