Chapter 31. Competitive Dynamics, Strategy, and Competence Development: The Rise of Value Confederations in Fast-Change Industries
David Lei
Over the past decade, much research has focused on the sources and conditions of approaches to building and sustaining competitive advantage. As companies compete in increasingly hypercompetitive environments, managers need to engage in multiple sets of activities (e.g., product development, entry into new markets, innovating new technologies), while simultaneously reducing the costs and risks associated with these strategic activities.[1]
As part of their effort to learn about evolving market trends and new technological innovations, firms are establishing closer relationships and strategic alliances with their customers and suppliers. Managers are seeking to improve coordination and information flow among internal functions, disciplines, and lines of business to enhance the search for systemwide solutions for developing new products and markets.
Findings from research and practitioner studies suggest that efforts to sustain existing sources of competitive advantage over an extended time period may well leave an organization vulnerable to challenges from new technologies, customer needs, and new rivals.[2] Building and sustaining competitive advantage is an ongoing Herculean endeavor that involves the cultivation and integration of many distinct factors, including technology investments; improved communication patterns within the firm; fostering new and diverse sources of knowledge; as well as organizational designs that promote fast-response capabilities and continuous learning.
Firms are finding that they are no longer the dominant repository of vital knowledge and competences critical to initiating and sustaining product development. In fact, over the past decade, managers have realized the need to work closely with a broad range of suppliers and distributors to build "value constellations" and "extended enterprises" to access a wider array of competences and skills.[3]
These relationships enabled firms to reduce some of the costs and risks of investing in new technologies. However, the notion of the "extended enterprise" is no longer limited to firms and their suppliers. The Internet provides low-cost information and direct communications among economic entities. Customers are becoming increasingly capable of fostering an ongoing and active forum with providers to co-develop ideas, new products, and services. In some industries, customers are becoming a primary source of future product development ideas, whereby they help educate the marketplace, fine-tune product features, and even shape market evolution and acceptance of new offerings.
As the walls and boundaries that separate organizations from their suppliers and customers erode, the nature of competition and strategy is changing as well. Firms can no longer conceive of themselves as isolated fortresses. Over the last decade, the proliferation of "value nets" or "value confederations"[4] has begun to reshape every industry. Today's industries are rapidly metamorphosing into an interwoven entity in which firms that possess a variety of different skill sets, knowledge bases, core competences, and technologies contribute their individual resources to shape an entirely new mode of economic competition.
A value confederation is a group of firms that compete against other firms or groups of firms—both within and across industries. For a growing number of industries, product development, technological innovation, and market entry are activities that require the resources, knowledge, skills, and competences of many entities. In addition to working closely with their suppliers, firms manage their product development and technology investments using customers' knowledge and skills as key ingredients for future sources of innovation. Many firms within a value confederation work with one another through formal and informal cooperative arrangements. At the same time, they also compete for new sources of knowledge and skills that will shape their future sources of competitive advantage.
This trend suggests that firms need to develop a capability to learn from a wide range of sources and to manage the knowledge-sharing interface between the company and other members of the confederation, particularly its customers. With the evolution of these value confederations, the nature of competitive strategy is also rapidly changing. In essence, as firms steadily rely on an expanding array of suppliers, customers, and other firms to participate in key value-adding activities, the growth and acceptance of new products and technologies will increasingly be beyond the control of any single firm. A multitude of technological and organizational factors are converging to redefine the context of strategy and competitive advantage in the value confederation. As new technologies enable firms to interactively share real-time data and information with their suppliers and customers, many economic activities will increasingly occur on a virtual basis within the value confederation, whereby design data, knowledge, insight, and even skills will be freely shared among the group of firms.
We begin with an examination of the critical features of the fast-evolving value confederation concept as it relates to promoting new forms of innovation. Next, we examine how the value confederation will likely shape the environmental context of competitive strategy for individual firms. Last, we examine what firms need to consider when investing their resources to compete and cooperate within the value confederation simultaneously.
Characteristics of the Emerging Value Confederation
As individual firms become part of a larger economic network, or confederation of companies, the nature of product development will change markedly to reflect the economic imperatives and conditions that shape the confederation's evolution. A value confederation is a network of companies that use a shared product architecture or technological platform to create and develop an overall value proposition that grows stronger as more firms enter the set. A key characteristic of the value confederation is that each firm within the confederation focuses on creating and delivering a specific, distinctive, economic contribution, such as a component, skill, or stage of production activity. Each firm concentrates its efforts on a specific activity that is mutually dependent upon the efforts and output of the other participants. While firms within the confederation may engage in formal strategic alliances and collaborative arrangements with each other, the value confederation may include numerous independent participants that operate without explicit alliance relationships. Arenas in which value confederations have proliferated in recent years include personal computers, storage devices, healthcare, defense products, semiconductors, multimedia, and online services.
Value confederations occur in those industries in which exist strong dynamics for increasing returns from network-based economics.[5] A key characteristic of increasing returns is that the more suppliers, firms, and customers join the confederation, the stronger it becomes. This propensity for mutual dependence among various economic entities that accompanies increasing returns gives rise to conditions whereby firms in the network are connected to one another through common architectural standards, technological platforms, or even through common information-based infrastructures. Participating members of the confederation can change over time, and in many cases, firms will often become members of multiple and even competing value confederations. Within a given value confederation, each firm focuses almost exclusively on a given activity, building a strong base of firm-specific knowledge and skills. Each firm develops and provides a distinctive contribution to the confederation's value proposition. The overall impact of this specialization is that innovation and product development activities become correspondingly dispersed among a growing number of firms, thus necessitating a high level of technological and organizational coordination among product and process platforms.
Specialization and focus on a given economic activity, however, does not preclude competition among members within the value confederation. Paradoxically, members of a value confederation will often cooperate and compete at the same time, thus engaging in what has been described as co-opetition.[6] As each firm contributes its distinctive offerings and value to the confederation, it also competes for preferred position within the confederation in order to capture a dominant share of the overall value-creation opportunity. Firms that are able to innovate faster generate new forms of knowledge or have greater access to a given market—for example, they may position themselves to gain significant competitive advantage and leverage over the entire confederation. Thus, each participating firm has two competitive objectives: (1) to create a distinctive source of value that enhances the overall value proposition of the confederation, and (2) to capture a disproportionate share of total confederation rents as possible. The confluence of these two economic objectives means that each firm's internal strategy effort must anticipate how best to innovate and to assimilate the latest technology or value-added offerings into its products in advance of what competitors' innovations and customers' needs may be.
Strategic Impact of the Value Confederation
The emergence of value confederations has provided insight into how firms will likely build sources of competitive advantage in the future. Even though value confederations have become particularly well established in those competitive environments in which common architectures and technological platforms exist, these same environments also exhibit a high level of investment risk and the frequent occurrence of potentially disruptive technologies. Consequently, an innovation that markedly changes the confederation's value proposition has collateral effects on each firm's individual sources of competitive advantage. On the one hand, firms feel the need to establish leadership in a key architecture or platform to establish industry and customer lock-in; yet, other firms may seek to redefine or even challenge the confederation's value proposition through disruptive innovations that fundamentally alter the nature of product design, process design, or buyers' needs (e.g., the rise of Sun Microsystems's Java architecture to challenge Microsoft's operating systems). Thus, within a confederation, firms must compete for those skills that enable them to secure a strong share of the confederation's overall value proposition, while understanding and perhaps investing in potentially competing technologies that could disrupt the existing value proposition in the future.
Accelerate Adoption of Core Technology Platforms
Firms within the value confederation must compete with one another to identify the best source of distinctive value, but competition must occur along a key technology platform or architecture. The essence of the value confederation depends upon cultivating a platform that establishes customer lock-in through high switching costs. Examples of platforms that create lock-in include operating systems for computers, algorithms that power wireless communication networks, technical standards for the transmission of audio and video streaming over the Internet, and the physical configuration of products for consumer electronics (e.g., VHS, DVD, CD standards). However, firms active in shaping the technology platform must look for ways to accelerate its adoption among other firms that seek to enter the confederation. By providing the technology platform to an expanding number of participants (often through low pricing, preferred access to new prototype designs, software code, or generous licensing arrangements), firms harness the power of increasing returns deterring outside firms from joining competing value confederations. Moreover, the stronger the lock-in that is established among member firms and customers, the greater the entry barriers for the entire confederation. The faster the confederation membership grows and the faster the technology platform or architecture becomes the standard, the greater the confederation's competitive position.
During the 1980s, Matsushita Electric of Japan cemented its dominance in the technological architecture for consumer-based VCRs by freely licensing its VHS format system to both its competitors and to content-based firms that produced films and other programming. Matsushita's strategy to create a dominant VHS standard by expanding its confederation to any firm willing to manufacture VCRs enabled it to outflank Sony. Eventually, Sony was forced to abandon its competing Beta standard as customers flocked to the VHS standard.
Compete for Share Within the Confederation
Product and/or process innovation become key for firms as they seek to capture and dominate a larger share of the confederation's overall value proposition. Often, competing within the confederation means investing in some key component or skill to support the technology platform or seeking a key competitive position within a critical market. A unique resource or asset that provides strategic leverage in a focused, value-adding area (e.g., manufacturing competence, software application, reputation, brand equity) enhances the firm's bargaining power within the confederation. Thus, competitive strategy within a value confederation requires firms to conceive how they can build on a distinctive contribution that simultaneously enhances and protects their bargaining power vis-à-vis other firms. In some cases, firms specialize in such a way as to exploit superior economies of scale or knowledge building a highly defensible position within the confederation. By dominating the "high ground," firms can establish a crucial foothold that enables them to carve out a core part of the overall value proposition.
Within the healthcare field, Impath has become well known for providing specialized cancer-related diagnostic support to physicians. Impath works with a broad array of hospitals, laboratories, and pharmaceutical firms to investigate and develop new diagnostic tools that help physicians better understand the different cancer treatment options that become available. This sharp focus enables Impath to become the knowledge hub for the entire medical community when it comes to modeling and understanding the progress of cancer treatment.
Invest in the Unknown
Members in the value confederation can seek to diversify their skill and competence sets by investing and learning about potentially disruptive technologies that could redefine the confederation's long-term competitive position, as well as each firm's relative competitive stance within the confederation. Small investments in cutting-edge, untested technologies might be the basis for future technology platforms. While there is no guaranteed payoff, these small investments do help the firm become more aware of potential threats. Excessive commitment to existing process technologies and product development routines may lead to inertia that makes rapid response to competitor developments all but impossible in fast-changing environments. Under ideal circumstances, investing across a range of different technologies and projects can help the firm to ensure that its knowledge base remains dynamic and permeable to ideas and innovations from partners, suppliers, and customers.
For example, Agilent Technologies (a recent spin-off of Hewlett-Packard) excels in the development of micro-array technology that is the basis for future DNA research, biocircuitry, and biotechnology. Already, many firms in the biotechnology industry are using Agilent's lithography-based approach to develop cutting-edge "gene chips" that are the basis for medical testing. However, Agilent's technology, while considered initially very promising, is not yet seen as the dominant technology platform for this emerging business. In order to hedge its investment risk, Agilent has invested in alternative micro-array technologies that utilize different process technologies in order to maximize its learning about competitive offerings. By understanding the alternative technologies that could give rise to newer micro-array technologies, Agilent can position itself to invest in new opportunities should they unfold.
In addition, firms may also directly invest in firms that possess the sources of disruptive technologies as a "hedge" in case the existing confederation's competitive position is challenged or deteriorates. Pharmaceutical firms, such as Merck, Pfizer, Bristol-Myers Squibb, and Pharmacia, have invested heavily in scores of biotechnology firms not only to learn about new genetic engineering technologies, but also to participate in shaping the possible evolution of new medicines and drug delivery systems. These investments enable each large pharmaceutical firm to broaden its network of relationships and to expand its scope of learning, while simultaneously limiting the financial and organizational risks from undertaking all of these initiatives internally.
An even bolder step in this direction is to participate in multiple, competing value confederations to diversify technology and confederation-based risk. For example, IBM has invested considerable resources with many software providers. It has made small investments in such companies as Siebel Systems, Ariba, and I2 Technologies, in order to see how its customers will use various software applications and new business exchange platforms.
Impact on Strategy Development and Growth Initiatives
The rise of value confederations across many industries has distinct ramifications for strategy development and innovation for growth. In fact, these imperatives are likely to change quite significantly as firms design new approaches to create value while competing within the confederation. A core driver of building competitive advantage within the confederation relates to how well the firm can position itself to capture a larger share of confederation value. As a result, core activities such as developing new product and process technologies must increasingly be coordinated among many entities within the confederation; no single firm can seek to control every aspect of product and process innovation. As the value confederation grows, the tendency for each firm to specialize in a focused activity will increase as well. Consequently, managing a parallel (and often competing) set of investment initiatives, while constructing effective knowledge-sharing interfaces among cooperating firms, will itself become a new organizational competence. Devising the architecture to coordinate these initiatives among the confederation's members entails a variety of new skills and approaches.
Competition and cooperation within the value confederation will compel firms to invest in core competences, resources, and skills that will enable them to exert a growing (and ideally, disproportionate) degree of influence over member firms within the confederation. Managing this duality of competition and cooperation (also known as co-opetition) requires a different strategic lens on how best to invest and allocate resources. On the one hand, each firm needs the other member firms to contribute their distinctive assets to fulfill the overall value proposition. On the other hand, each firm competes with the same exact set of firms to learn new skills and insights, to develop new products and processes, and to capture a greater share of confederation rents. The nature of this behavior gives rise to a set of strategic conundrums that will place a great premium on each firm's ability to reinvent itself in a number of different dimensions.
An Emphasis on Seeking Modularity
A focus on utilizing core competences and resources to make products, services, and technologies more modular can substantially increase the firm's bargaining power within the confederation. Modularity refers to the economic concept in which product/service and component designs are sufficiently flexible to provide a range of variation in their final configuration or use without entailing a fundamental change in the basic design or layout.[7]
As the confederation's overall value proposition is unbundled among a growing number of member confederation firms, modularity becomes an important driver of product development in particular. Modularity offers a high level of what might be termed embedded coordination, since product components, skills, and technologies share a common set of standardized interfaces that allow for mixing and matching among the confederation's member firms' value contributions. Within each firm, product development needs to focus on maximizing the creation and use of self-contained modules (e.g., components, software, system drivers) that can quickly and seamlessly fit the offerings of other confederation firms. Product modularity thus enhances the mutual interdependence among firms. The greater the modularity of a firm's offering, the greater its economic usefulness to other members in the confederation. Consequently, a focus on enhancing modularity in product development will encourage firms to innovate in such a way that product architectures and technology platforms are distributed as broadly as possible so as to maximize the economic reach (and also the barriers to entry) of the entire value confederation.
As product designs become more modular, it is important for the knowledge base and core competencies of the firm to assimilate new technologies, insights, and skills. Ideally, intrafirm investment should be oriented towards making the firm's core competence more modular, so that the underlying technological, organizational, or knowledge-based components allow for an increase in its capacity to learn, internalize, and apply new skills to future product ideas. A modular core competence is one that accommodates and allows for a growing range of insights into the development process. As product designs become more modular, so should be the firm's approach to building its competence base. Over time, firms will likely race one another to develop both modular core competences and modular product designs in their ongoing attempts to capture a disproportionate share of value-creating activities in the value confederation.
The consumer electronics, personal computer (PC), and related multimedia industries already exhibit a growing degree of modularity-based strategies pursued by firms competing in these arenas. New products, such as MP3 players, CD burners, advanced computer platforms, videogame players, and software upgrades increasingly must be compatible with both previous as well as future design configurations. More importantly, offerings, while remaining distinctive in performance characteristics and appeal (e.g., Intel microprocessors, Apple Macintosh computers, Microsoft Windows platforms, Sony Playstation game boxes), are becoming increasingly modular in their consumer applications. Product technologies originally conceived for a narrowly defined application (e.g., computing or videogames) must now be easily configured for use in previously unforeseen arenas. For example, Sony's Playstation systems now feature not only advanced software and video graphics, but also Internet connectivity and DVD players that allow users to capture much of the benefits of earlier generation PCs. As Sony's Playstation line of videogames incorporate state-of-the-art microprocessors from IBM, Toshiba, and other firms, it is widely anticipated that the Playstation architecture could become an important competitor to next generation DVD-driven applications for both PCs and the consumer television markets. Conversely, Apple's Macintosh computers now feature desktop publishing that allows users to create their own full-motion video films and presentations, communicate on the Internet, and connect to a whole range of new digitally-driven consumer electronics applications that are still in the works.
Enhancing Fast Innovation Capabilities
Each firm within the value confederation focuses on its own source of distinctive value. As confederation members become mutually interdependent, product innovations occurring in one firm can dramatically impact the nature of product development in another. Within the confederation, firms jockey for a stronger competitive position by creating new skills and assimilating new sources of knowledge. The cumulative impact of such intraconfederation competitive behavior suggests that power and influence within the confederation will likely accrue to the firm that is able to innovate the fastest. While specialization by individual firms remains key, the capability to lead the confederation in pioneering new designs, process technologies, and entry into new markets enables the innovating firm to command significant influence, if even for a short time. As such, one major driver of intrafirm investment for member firms will be choosing a particular attribute or element of the overall value proposition and allocating sufficient resources to dominate it as much as possible. Under the most ideal conditions, the value-creating skills and insights possessed by any given firm should be inimitable, while the final product or service offering itself leads the confederation in terms of modularity and knowledge contribution in advance of other firms.
Combining Disparate Sources of Knowledge
A new type of organizational competence may take root for some firms within the value confederation—orchestrating the technological standards, architectures, and product development activities of individual firms. Firms may specialize in this orchestration role by combining the distinctive offerings and skills of member confederation firms into a larger value proposition. Thus, by identifying emerging market trends, planning the format of future technical standards and products, and encouraging member firms to work more closely together on such initiatives, firms may serve a vital integrative role. Japanese companies, in particular, have been practitioners of such orchestration strategies through their complex alliances and cross-holdings in suppliers and other firms. This keiretsu arrangement, while substantially different from our notion of a value confederation, seeks to share knowledge and technologies among key members who provide design, production, and other technology expertise.[8]
Other firms may create technological breakthroughs and become "industry statesmen," promulgating the new standards or designs among competitors in the arena. One linchpin to this approach is the simultaneous dominance and low-cost proliferation of a given technology or architectural standard that enables both suppliers and competitors to become disseminating agents of the core platform. It is imperative that the firm retains control over its intellectual property and continues to invest in the core platform to sustain dominance, while encouraging likely competitors to utilize its architectural standard, core platform, or underlying technology. The duality of this strategy requires that the innovating firm capture high profitability and competitive advantage through the increasing returns that accompany higher adoption both within and beyond the industry. Winning these "architectural wars" requires the innovating firm to ensure that its technology vision is rapidly adopted by firms likely to become important future competitors. As the technology or architecture becomes the de facto industry standard, increasing returns encourages greater usage, member participation in the value confederation, and adoption of the firm's innovation to potentially new and unforeseen applications.
In pursuing an orchestration-based strategy, firms will need highly integrative skills that can manage product development approaches concurrently among multiple firms. Strategic orchestration and architecture creation demand a higher level of meta-learning and dynamic routines that encompass intrafirm creativity and innovation that spans across other firms. This orchestration-based strategy to product development could well represent another type of competence set, since the skills required for integrating different product designs and features call for an exceptional insight into technology, competitor trajectories, and customer needs.
Although high-technology hardware and software industries exhibit many firms attempting to set the standard for their respective offering, the concept of providing a common architecture to set the rules for competition are found in many other industries as well. For example, highly innovative firms in the automobile industry not only produce and assemble their own cars, but also provide a central linchpin around which dozens of specialized design firms submit their ideas and styles for consideration throughout the confederation. Honda and Toyota lead not only in continuous product improvement, but also in upgrading each car's overall "product integrity," whereby individual components work together to improve ergonomics and driver comfort as well. As other member companies supply next-generation components to Honda and Toyota, they also become implementers of new technological advances that redefine cars' functionality and features. In the networking industry, Cisco Systems serves as a prime example of this orchestration role. The company manages its own internal product development efforts with those of chip suppliers, software developers, fiber optic firms, and other component suppliers to ensure that all providers are designing their offerings along a common, modular standard. Cisco even encourages its competitors to share in the technology that is developed over time, since product design compatibility among a wide range of competitors encourages customers to upgrade their equipment needs without an overriding fear that technical standards will not be compatible from different vendors.
Competing on the Cutting-Edge: Renewing Advantage via Learning
As the value confederation form of competition grows, firms will face renewed and heightened pressure to continue to invest in future products, technologies, skills, and markets. This trend suggests that firms will need to steadily invest in creating new sources of knowledge, both within and external to the organization. Each firm will face a growing, unprecedented degree of interdependence with other firms, including competitors, suppliers, and even customers. This interdependence means that each firm must not only invest sufficiently to build and refine its own sources of innovation and competitive advantage, but also to stay ahead of likely competitors who may have similar corporate ambitions and growth trajectories.
As we enter the new millennium, it is clear that firms of all sizes face complex and even contradictory signals from the competitive environment. In some arenas, firms are downsizing and shedding businesses that no longer fit their core competence. In other arenas, companies are aggressively acquiring their rivals and investing ever-higher sums into new and often unproven technologies. While the competitive environment appears to exhibit signs of economic entropy, much of this innovation and change-driven "chaos" is actually an accelerated process of "creative destruction," whereby new technologies and products are rapidly displacing those of established firms. Thus, a key strategic imperative for any firm is to find the right balance between investing in existing products and markets (mostly profitable activities) and devoting resources to investigating and learning new skills and knowledge (decisions that are often subject to considerable internal debate). Competition is certain to hasten these economic convulsions. Moreover, any given firm within a value confederation will face continued challenges from similarly endowed (if not better) competitors seeking to drive innovation and value creation. As we have already seen from numerous corporate experiences over the past decade (e.g., Eastman Kodak), firms that were slow to grapple with change and to embrace cutting-edge products and technologies face an agonizing process of decline. However, firms that are able to navigate and even participate in shaping the future of their respective value confederations will not only win a disproportionate share of profitability, but also will set the pace for future technology-driven investments and customer expectations.
For senior managers, perhaps the most compelling strategic consideration is not to focus excessively on sustaining existing sources of competitive advantage, but rather to learn and build renewable sources of advantage for the future, such as investments in core skills and knowledge that can be easily adapted to fast-changing technologies and markets; more often than not, renewable advantage emanates from a "social fabric" that promotes experimentation, risk-taking, and knowledge-sharing across multiple lines of business and products. Equally important, managers need to inculcate within their organizations a diverse base of insight and experience to build a portfolio of talents, since there is no way to predict how competitive strategies (and the skills required to support them) are likely to evolve over the long-term.