Industry Architecture

Current economic turmoil has prompted radical changes in rules and roles of various industries. As the industry architectures adjust themselves to respond to the recession, many industry leaders will be reduced to industry laggards, while many newcomers will capitalize this opportunity to become giants. This is not a new phenomenon as all sectors evolve over time and their industry architecture reshapes, but they do it at different pace and at different time cycles.

However, today we are living through a unique time in several ways. Not only is this recession probably, the worst since the Second World War, but it also caught us by surprise.

So much for the bad news. The silver lining to the cloud is that a better understanding of the industry architecture will help us to understand the opportunities and pitfalls in the current times. This crisis could be a wakeup call, showing us how some companies manage industry architecture to their advantage and how some industries are dangerously unstable. Armed with this insight companies can take advantage of the opportunities presented by this downturn to reshape companies and even sectors.

So what is Industry Architecture and why does it matter?
Industry architecture consists of roles played by companies in a sector and the rules (standards, regulations and conventions) that connect them.

These roles, rules and relationships define the way in which money is made i.e. companies business model. They influence “who does what” (Strategic choices and what each role is in the industry) – which in turn determines “who takes what” (revenue, market share, competitive advantage and profit). However, they are not static – they change substantially over time.

Consider early days of computing, where the industry unbundled, vertically disintegrated, changing the competitive dynamics and even the identity of the sector. IBM outsourced too much during the 1980s giving up critical business functions. Meanwhile, Apple of late 1980s was too integrated and closed losing the battle for personal computing and allowing previously unknown companies to capture the key parts of its value proposition. Both companies came close to failure.
Microsoft, by contrast, used creative agreements to maintain its position as a key stone, retaining the key parts of computing value-added process and guaranteeing a foothold in the critical area of graphical user interface, operating system and pre-installed software. Crafting and excellently executing on these strategies including OEM strategy made Microsoft a household name. Companies such as Microsoft do not just work in a sector – they work on it, shaping the sector and ensuring that the future of the industry will fit their capabilities. IBM and Apple’s more recent history suggests that they too managed to overcome their previous failure by becoming more savvy managers of their sectors architecture.

Consider financial services for instance. Over the past decade, we have seen new instruments (securitized loans and later collateralized debt obligations), new rules (often prompted by the companies and individuals who stood to benefit from them) and new models (various types of hedge funds). These changes transformed the way money was made and created new winners: securitizes in the beginning of the decade, hedge funds and private equity shortly thereafter and (until the collapse) and their employees.

What is interesting about the industry architectures is that they often change without us noticing. This term Industry architecture was coined in 2006 by Michael G Jacobides, associate professor of strategic and international management at London business school. Since nobody is meant to monitor them, industry architectures can lead to boom or bust or both. If you take a step back and get a sense of the entire system, you might see the risks and opportunities. But if you do not, you might step into the meltdown. For instance, each successive change in financial services was eminently sensible in isolation, but their cumulative impact was disastrous and someone should have foreseen it.

Consider the increasingly untenable position of large telecommunications operator, which have been challenged by new ways of making money and having to reposition themselves constantly vis-à-vis content providers, handset manufacturers and service providers.

Rethink your role, reshape the architecture
As downturn became recession and credit evaporated, other industry architectures are up for grabs. Recessions cause transformations in the way we do business. The 1970s downturn gave European and US Manufacturers the chance to change their practices and re-organize their supply chain. The early 1990s recession helped spur the growth of outsourcing. And the IT slump at the start of this decade ushered in a new type of networked organization and flexible workers.

When sectors are growing, everyone is busy making money. They carry on doing what they have always done, even if it is inefficient, and nobody wants to voice any doubts or change the sector. But when the going gets tough, companies are willing consider entirely new ways of doing business and established leaders may be unable to prevent changes in the structure of their sector.

Consider the UK construction sector, which was stable for decades and inefficient for a very long time. New ideas such as “design for build ability” and “design for cost minimization” only took hold when the 1990s recession forced existing players to change the structures and span more parts of the value chain in order to survive.
Crisis means new industry architectures. That means new opportunities for those who can adapt and challenges for those who think that a downturn can only mean lower output, lay-offs and retrenchment. Customer needs are different in a downturn: consumption shifts from an aspirational, image-driven model to an emphasis on thrift and value, as we can see from the spike in sales of low-price retail chains such as Wal-Mart, Aldi and Lidl over the Christmas period in US and Europe.

Business-to-business relations are being redrawn, shifting the focus from growth to preserving cash. Capital markets are pre-occupied with risk. And regulators are aiming for corporate survival at all costs, where once they sought competition. This is why downturns are associated with rapid changes in a sector’s pecking order – a threat for those at the top and an opportunity for those hungry for success.

So what should companies do?
Adapting to a new reality, changing the way you do business or reshaping your industry’s architecture is no mean feat. First, you need to work out how you can add value in the new environment. This requires realigning what the company does to match emerging needs. It means reconsidering how the organization is structured, and how its financial and capital structure translates success into results.

To do this, you must clearly express why and how a company can add value, and explain how it can continue doing so as the downturn deepens and conditions change. You have to decide how to reposition the company in the sector, distinguishing between temporary lulls and profound clinical changes, and consider what could be tenable in the future. You need to plan for the worst while plotting your course to emerge stronger from this difficult period.

The phenomenon of adjusting to industry architecture and redefining industry architecture is not new. This can be done in good times or in turmoil like today. For instance Merrill Lynch (in USA) launched its cash management account back in 1978. This combined traditionally separate banking products such as line of credit, check, investment and equity accounts into a single monthly statement, with idle funds being swept automatically into a high-interest-bearing account. The new accounts attracted US$1 billion of assets in first year. Merrill Lynch set out to change the shape of the financial marketplace permanently by taking several existing but separate services and tying them together through information technology to create a new service that shattered the traditional boundaries between the banking and securities industries.
In another instance, in 1980s Otis Elevators, the US manufacturer of elevators, identified ‘customer services’ as being a key element of its customer strategy to overcome the price wars. It decided that one of the aspects of its service that would give its customers most satisfaction was a prompt lift repair service. So, it built an automated system, called Otisline, to dispatch repairmen. Where something started to go wrong with Otis’s lifts, they (the lifts!) automatically called in their complaint to a computer – without human intervention. Otis’ rivals suddenly had to compete on quality of service as well as the price and quality of lifts themselves.

Thinking about the industry architecture can also help to dispel the doomy introspection that accompanies downturns. In tough times, everyone looks inwards, obsessing over redundancies, politics and re-organization – losing touch with customers and the market just when they can least afford to. Finding a way to refocus on value, on what lies behind the financial results, could help to combat this dangerous tendency. It could be just the challenge you need to energize and awaken the talent in your business and restructure company and your sector.

Companies that have the courage to do so, do much more than manage their operations & costs to return to profitability. They identify which parts of their business are viable and which are not, taking the crisis as an opportunity to take a strategic look at their future and that of their sector. We know that companies do not change unless they are forced to, and managers have used “burning platforms” as an opportunity reorganize from time immemorial. The good news is that no one needs convincing that the platform is burning. The flames are around our ears. What is important now is not to let good crisis go waste.