The Challenge Network

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Three cores to each company

Three cores to each company

Companies are traditionally organised to minimise interaction costs. These occur whenever people and companies exchange goods, services or ideas. These exchanges can occur within companies, between companies, and between companies and customers. Interaction costs determine the way companies organise themselves and form relationships with other parties.

When the interaction costs of undertaking an activity internally are lower than the costs of undertaking it externally, companies tend to incorporate it in their own organisation rather than contract it to outside parties. All else being equal, a company will organise itself to minimise its overall interaction costs.

Changes in interaction costs can cause entire industries to reorganise rapidly. Electronic networks now enable companies to exchange data more quickly and cheaply than ever before, questioning previous assumptions about corporate organisation. Activities that were central to a company's business will be offered by new, specialised competitors.

One company, three businesses

Within most companies there are three kinds of business: a customer relationship business, a product innovation business, and an infrastructure business. Each plays a unique role, employs different kinds of people, and has different imperatives.

The role of the customer relationship business is to find customers and build relationships with them. This may involve obtaining new customers, assisting customers and building personal relationships with them, responding to questions and complaints, and collecting customer information.

The role of the product innovation business is to develop attractive new products and services, and figure out how to bring these to market.

The role of the infrastructure business is to build and manage facilities for high-volume, repetitive operational tasks such as logistics, storage, manufacturing and communications.

These three businesses rarely fit neatly into a company's organisational structure. Rather than representing organisational units, they correspond to core processes. But conventional wisdom is that the management of customers, innovation, and infrastructure must be combined within a single company. If these activities were split into separate companies, the interaction costs to co-ordinate them would be too great.

But the imperatives governing these three core processes conflict. Bundling them into a single company compromises the performance of each process. Finding and developing relationships with customers requires time and investment. Profitability depends on achieving economies of scope, extending relationships as long as possible, and on generating the highest possible revenue from them. To achieve economies of scope, such businesses usually wish to offer as many products and services as possible, and create customised offerings. These priorities create a service-oriented culture.

But product innovation businesses require speed not scope; the faster they move, the more money they make. They focus not on customers but on attracting and retaining the talent needed for innovation. They are small organisations rather than large bureaucracies.

Infrastructure businesses are driven by scale. They usually involve capital intensive facilities with high fixed costs, so achieving high utilisation is the key to profitability. They abhor customisation and special treatment.

When all three businesses are bundled into a single company, their divergent economic and cultural imperatives inevitably conflict. Scope, speed and scale can not be optimised simultaneously and tradeoffs have to be made. To protect manufacturing scale, a company might prohibit its salespeople from selling another company's products. It might institute standardised pay scales that alienate its most talented product designers. To protect customer relationships, it might require customisation that slows product innovation and creates production inefficiencies.

Organisation fault lines

Some industries are already unbundling along the lines indicated above. In the newspaper industry, all three processes were once integrated. A newspaper attracted customers - readers and advertisers - developed most of its product - news stories - and printed editions on its own presses and distributed them with its own trucks. Now, much of its product is outsourced to specialised news services. Many rely on specialised printers to produce the paper and contractors to distribute it. As newspapers move away from product innovation and infrastructure management, they can concentrate on the customer relationship part of their business: helping to connect readers and advertisers.

In the pharmaceutical industry, some product innovators focus on specific techniques and disciplines, such as gene mapping or dermatology. On the infrastructure side, some companies outsource the planning and execution of trials to contract organisations, and distribution specialists now warehouse and deliver most drugs.

Organisation and the internet

To look into the future of business organisations, we need only observe how internet companies are organising today. Portal businesses such as Yahoo! rely on other companies to provide their web-based products and services on one hand and infrastructure management on the other. Even Yahoo's search engine is now provided by another company. It can thus concentrate on attracting customers, gathering data about them, and connecting them with advertisers and merchants. It is becoming an infomediary: a company whose store of customer information enables it to control the flow of commerce on the web.

On the other hand, is at present focusing on both customer relationship management - its user-friendly web site, vast selection and low prices - and infrastructure management - the network for processing and delivering orders. Its massive financial investments are in the latter. Soon it may have to focus on just one of them, or unbundle itself into two separate organisations.

Small companies that have emerged on the web are now gaining control over customer relationships. They provide car buyers with information about current models and pricing. They then collect information on customers and refer them to appropriate dealers. Car dealers will have to rethink their role. They could give up the customer relationship business entirely and focus on the infrastructure business - managing showrooms - while infomediaries take over the role of acquiring and managing customer relationships. Car manufacturers may have to unbundle their business, outsourcing customer relationship and even manufacturing, focusing on product innovation.

A road map for unbundling

As more and more industries fracture, many companies will find themselves cut off from their customer base, and to reach their markets they will have to compete or co-operate with infomediaries. They may have to unbundle and decide on which business to focus: customer relationship management, product innovation, or infrastructure management.

The economic forces driving these three types of business are different. Although industries may fracture, they will not necessarily break into many small pieces. Only product innovation is likely to be characterised by large numbers of small businesses. The other two types of business will probably consolidate, as a small number of large companies achieve dominance. To do this, they will have to build scope or scale by mergers, acquisitions and alliances.

Rebundling is a different process from vertical integration. Because companies will focus on a single activity, they will aim at achieving horizontal integration. They will seek to build scope or scale first within their own industries, and then to leverage their capabilities across related ones.

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