By Ola Henfridsson and Joe Nandhakumar
Just a decade ago execs at the Financial Times talked about being in the newspaper industry and nervously looked at their rival UK broadsheets The Times and The Daily Telegraph.
Now, with its business model smashed by the internet, the Financial Times’ rivals span the seemingly endlessly wide rainbow of online news sites across the internet.
Similarly those in the music industry 10 years ago were wondering what Warner Brothers and EMI were doing in their boardrooms, now it is Spotify and Apple and a host of streaming sites across the world wide web who dictate the pace of change.
The digital revolution has disrupted and broken industry boundaries to such an extent that the very notion of working in an industry is dead.
Every MBA student is familiar with Michael Porter’s Five Forces in building a strategy for a company. The oft-quoted strategic tool starts with defining the industry and then building barriers to stop rivals entering.
But thinking about your industry is irrelevant in the digital sphere, barriers are just not possible, especially as the fourth industrial revolution evolves around us with almost everything, from cars to ovens, being connected to the internet.
As a strategy tool Porter’s Five Forces is less relevant in the digital world. Instead, strategists in the digital age need to think about what we term ‘value paths’ and how their digital product or service can be recombined by users, whether that is a person or another company or even a bot.
Creating value through innumerable connections is how to prosper in the digital world and that involves actively leaving your product open, not building barriers.
To understand where your digital offering fits in the complex web of the digital world we have formulated the ‘Value Spaces Framework’ as a tool to map the connections and visualise the value paths available.
Traditionally a product or service can be described as a vertical, such as a car. It may be made up of many different parts from different suppliers, but it can only be assembled in one way to make that one product. Thus, it has a clear product boundary and strategy frameworks like Porter’s Five Forces look at the product and its industry with that kind of mindset.
The whole industry is based around that product, and value is created within those parts that combine a car. So car manufacturers can compete on features like braking, cornering performance, chassis style and engine power against other cars in the same industry and position themselves around certain features.
But in the digital world value is not created within those vertical industries, instead it arises in horizontal spaces, cutting across industry verticals. Today, for a carmaker, what goes on in Google HQ is just as important as to what is happening at Ford or GM.
This is because these digital resources are agnostic, in the sense that their meaning is largely defined by their relationships to other digital products or services.
A chair is purpose-built, the parts cannot be used for anything else other than being part of that chair, but a digital product or service can be used in many different ways, it can be recombined with other digital resources to make a totally new service.
Joseph Schumpeter introduced the notion of recombination as innovation in the 1930s, but the digital world has taken it to a new level. Schumpeter was talking about companies recombining features to make new products, where the design team might take the different components of a car to create a new model.
Why strategy is all about innovation in the digital world?
In the digital world there is also what we call ‘design recombination’, where the firm purposely recombines digital resources to deliver a new offering. But digital resources are also being recombined by users. They are being left open for users to recombine with other digital resources in ways the designer has not even imagined.
Take Google Maps, a product, thanks to its open API, that, as of February 2012, was embedded in 2,337 other services, all using it in different ways to mix and match with other digital resources to create new value for consumers. It is the same content, but it invites users to recombine it in thousands of different offerings.
Google Maps can be a stand-alone service in a web browser, but is also a digital resource that can be used as a building block in the creation and capture of value in services like Rightmove. The UK-based online real estate portal uses Google Maps to plot properties available on its site.
Although there are some terms and conditions involved it is nothing like the car manufacturer signing a long-term contract for a new navigations system supplier. It is a very lean system, Rightmove can, in theory, move to another map supplier relatively quickly if it wanted.
In our Value Spaces Framework we have four horizontal levels of digital architecture where value is created:
- Contents – this is data or information like music, news and video that is stored and shared.
- Service – functional software like heart monitors, social media apps and media browsers, which directly serve users as they create, manipulate and consume content.
- Network – the transmission software and the physical cables of the digital world.
- Device – hardware like smartphones and software that enable storing and processing.
So a digital resource, like Google Maps, would sit on one of these levels, most likely contents. Thanks to its open-ended nature Google Maps has 2,337 value paths connecting it to other digital resources either across value spaces on the contents level, or up and down the various different levels of the framework. It is these value paths that are the key to success in the digital world.
The more value paths created, the more important the service becomes and the more users it has – this is the network effect, where the more users there are, the more valuable the service becomes for those users. Even if it does not lead to network effects, the value path can still be monetised, whether it is through advertising, subscription or selling the data on to third parties.
To compete in this world firms need to create as many value paths as possible through their digital resources, what we call path channelling. Once a firm has realised its position on the Value Spaces Framework, it can plot ways to cut paths to other digital resources by creating better and more user-friendly value paths and so channelling the value from ecosystems dominated by others to themselves instead.
This is a competitive strategy that Google is adept at. For instance, in its attempt to tap into the value paths dominated by Microsoft in word processing Google has offered users of Microsoft Word plug-ins to make Word work directly from Google Drive. Thus, Google is seeking to channel value paths through its own digital resources and increase its ‘value intensity’ – this is a rough measure of a digital resources through number of uses or hits on a web page.
It is a very different mindset to the traditional industry-orientated startegising where creating barriers is necessary. The digital world is the opposite, it is about lowering barriers and being as open and as easy to use as possible – you want other users to take it on and re-create it to generate more value paths.
Thinking of and defining an industry is an irrelevance, after all which industry is Google Maps in? Is it housing or cars or something else? With it being used in 2,337 other digital services it is impossible to define and it doesn’t actually matter. A company, instead, wants to dominate these horizontal layers which we refer to as value spaces.
We have seen industries disrupted by digital innovations time and again, and many more are facing this now, such as the car industry. The car is increasingly becoming digitalised, which means more and more of the value that is produced for the customer is related to digital.
As long as car manufacturers keep outsourcing the digital services inside its cars to somebody else, they will quickly lose control of what is creating value and hence the opportunity to monetise. The car will just be the box for the value paths owned by other companies.
Google maybe testing its own autonomous car, but it is unlikely it is looking to enter the 'car industry' – it thinks much bigger than that. It is all about data and maybe it is looking at using all that data from Google Maps, which has traffic flow data, plus its search engine and mobile phones to redefine transportation around a connected smart city.
It is thinking in this horizontal way, at how it can combine many digital resources to solve transportation – and data will be the key. Data can allow it to control all cars and the traffic flows, then the carmakers become suppliers for Google.
Instead of thinking about an industry, the Value Spaces Framework prompts companies to look through industries and at the value paths they can create that break those artificial boundaries. In order to be relevant firms want to have overlap between their offering and most of the users in the space they are targeting.
Car companies want to engage with the customer and generate data about the customer that can be turned into value, but it is very difficult to turn that information into something useful unless they open up and become part of the digital ecosystem, allowing others to recombine the digital resources in a car.
But this is where it becomes very difficult and where a company needs to understand its position in the Value Spaces Framework. Opening up could increase a car company’s value with more value paths, but it could also be hijacked by users.
Apple spotted this dilemma very early on. It was not the inventor of the App Store. When it released its first iPhone it found users breaking into it and installing applications. It could have tried to stop this through legal means and security software, but instead it saw the potential in creating many value paths for its product and devised, with the hackers, the App Store to make downloading applications available to everybody.
But Apple also realised the danger in Google Maps sucking value paths out of its phones and so uninstalled it, cutting the value paths by creating its own map service.
In the digital world this re-assessing and hunting for value paths is constant as, without boundaries, a new value path can come from anywhere. If a company is not innovating then it will be overtaken, it has to be updating and looking for more value creating paths all the time.
Digital innovation is at the heart of any strategy in the digital age and to be successful doesn’t stop at a one-off cleverly designed resource. Launching the product or service is just the beginning, it then needs to be attractive enough so it is recombined many times by other users, with new updates and value paths constantly being sought.
In the digital world, innovation is not a way to get ahead in an industry, it is a way of life to thrive in an ecosystem.
Henfridsson, O., Nandhakumar, J., Scarbrough, H. and Panourgias, N. (2018) "Recombination in the open-ended value landscape of digital innovation", Information & Organization, 28, 2, 89-100
Huang, J. C., Henfridsson, O., Liu, M. J. and Newell, S. (2017) "Growing on steroids : rapidly scaling the user base of digital ventures through digital innovation", MIS Quarterly, 41, 1, 301-314
Yoo, Y., Henfridsson, O., and Lyytinen, K. (2010). “The New Organizing Logic of Digital Innovation: An Agenda for Information Systems Research”, Information Systems Research, 21, 4, 724-735.
Joe Nandhakumar is Professor of Information Systems and lectures on Digital Business Strategy on Msc Management of Information Systems and Digital Innovation.