Business Ecosystems and Innovation

Introduction

Since the concept originated in the 1990s, interest and research in business ecosystems has become prominent within management literature. The establishment of the ecosystem concept is attributed to James Moore in his 1993 article “Predators and Prey: A New Ecology of Competition.” Moore utilized the metaphor of natural ecosystems to explain the complex, dynamic and evolving characteristics of modern business and competition.[1] Moore proclaims that an organization can no longer be confined to a single industry, but is rather a member of one or more business ecosystems that span an array of industries and signify the essence of our modern global economy.[2] A business ecosystem can be defined as organizations coming together in a structured community as they co-evolve capabilities around new innovations.[3]

There are many advantages of business ecosystems as mentioned in the literature. Co-opetition Theory suggests that firms add value to consumers by working together to find complementary products and services.[4] For example, applications developed to work on the IOS operating system add value to iPhone customers by increasing the amount of features that can be used on the phone. This can also be seen within the Google and Amazon ecosystems, including the voice assistant devices—Google Echo and Amazon Alexa. These devices have become popular among consumers as companies seek to integrate their products and services into the network of devices that parallel to the voice assistants. Although consumers benefit from the wide range of products and applications within each ecosystem, they cannot mix ecosystems, forcing them to choose one or the other.

Paradoxically, the forces that create shared value among businesses operating within the ecosystem may actually reduce innovation and consumer choice due to increased switching costs and the potential for oligopolistic market structures to develop. According to the Merriam-Webster’s Dictionary, the legal definition of an oligopoly is a situation where a few sellers control a particular market to the detriment of competition by others.[5] For example, airlines and oil companies are often considered oligopolies because they operate without an abundance of competitors. This type of market structure occurs when there are high barriers to entry. This article identifies that business ecosystems can create barriers to entry as companies co-evolve capabilities around specific technologies and platforms. The outcomes suggest some potential damaging effects to consumer markets and innovation that business leaders should consider.

Business Ecosystem’s and Oligopolistic Market Structures

Although the classical view of competition is that organizations compete with one another based on their products, numerous factors—mostly associated with technological advancements—have changed the nature of competition in the 21^st century. No longer do companies compete based on who has the best products, but rather companies now compete based on their ability to construct the best “platforms” and cultivate innovative ecosystems around them. Business ecosystems generally begin by structuring themselves around a platform. A platform is an asset that provides an infrastructure of reusable common components that can take the form of a product, service, tool, or technology.[6]

As a result of the value it creates for others, platforms have the ability to foster and incentivize a significant number of other firms to build and contribute complementary innovations to the core components. Organizations that are able to successfully accomplish this and share the platform’s value with its contributors are able to establish themselves as Keystones within their respective ecosystem.[7] The ability to successfully execute a platform strategy can provide Keystones with a sustainable competitive advantage over competitors and other smaller ecosystems, because the whole is able to create synergy while simultaneously erecting barriers to entry.

Throughout the literature, many companies including AT&T, Verizon, Hewlett-Packard, Dell, IBM, Walmart, Microsoft, Apple, Intel, Google, and Facebook, have been used as examples of organizations that have effectively developed successful platforms, cultivated ecosystems around those platforms and, therefore, have become Keystone organizations. Although these firms have been championed for their ability to succeed in today’s increasingly volatile competitive environment, it is clear that when looking deeper, many of these organizations are leaders in industries that are significantly consolidated or structured as oligopolies, where a few companies dominate the vast majority of the industry’s market share. Below are some examples of Keystone organizations that utilize platforms in their industry.

It can be seen from the information above that there is a connection between business ecosystems, keystone organizations, platforms, and oligopolistic market structures.

Potential Drawback of Oligopolistic Markets on Consumers

Impact on Innovation

Characteristics associated with platform ecosystems, such as network effects, have the potential to erect many barriers to entry. These barriers to entry, whether they are a result of network effects, switching costs, or path dependency, act as a deterrent to innovative or creative new entrants from competing within the industry. As a result, in the industries where platform ecosystems and network effects are present, oligopolistic market structures generally are as well. Although this market dominance can be attributed to the effective development and implementation of platform strategies by industry leaders, this market concentration results in large and powerful companies almost completely controlling the market. Therefore, this makes it extremely difficult, and sometimes nearly impossible, for new entrants to break into the industry and effectively compete and survive amongst incumbents.

As can be seen in the diagram below, business ecosystems progress through four stages within a life cycle: birth, expansion, leadership, and self-renewal, with each stage presenting its own unique characteristics, features, and challenges.[14] [15] As ecosystems progress through these stages, the collective evolves from, “…random collection of elements to a more structured community.”[16]

Figure 1: Ecosystem Development Cycle

In the Self-Renewal stage, ecosystems face threats from new innovations or rival ecosystems or changes in economic conditions, consumer needs, and governmental regulations.[17] [18] [19] Markets also become concentrated during this stage as organizations erect barriers to entry to avoid competition. According to the Population Ecology perspective of inter-organizational relationships, this development of concentrated industries that are protected from new entrants has the potential to limit innovation and, therefore, negatively affect consumers.[20] Firms often become very large and control a large amount of resources in markets dominated by a few players. For example, as of 2009, Walmart’s revenue exceeded the annual GDP of countries, such as Greece and Egypt.[21] However, as organizations grow larger, they become more mechanistic and lose the flexibility needed to quickly and effectively adapt to changes in the external environment due to the phenomenon known as organizational atrophy.[22] It is also politically less risky to maintain the status quo rather than attempting to identify and fix new problems.[23] As a result, these industries that become oligopolistic are characterized by large, archaic organizations that are unable to innovate and adapt to changes in consumer needs effectively due to large investments in fixed assets, limited information, and the bounded rationality of organizational decision makers.[24]

When companies work together by using a shared platform, it becomes easier to collaborate, allowing for incremental innovations. For example, programmers developing applications for Windows need to work within the requirements of the operating system. In this way, application companies and Microsoft are working together to create additional shared value. However, the Windows platform also has some constraints that limit the ability of software developers to innovate. For example, Electronic Arts may wish to develop a game that requires a faster operating system than what Windows can handle. Because of this constraint, they may delay any major improvements to the software until the Windows operating system gets an upgrade.

Pioneering innovations are regarded as projects that develop specific new technologies, market categories, or products.[25] These projects typically take a long time to develop, but are expected to bring high returns. Incremental innovations, on the other hand, are product modifications developed to meet a specific market need.[26] Because companies that operate within an ecosystem often use a shared platform, they may be limited in their ability to develop pioneering innovations that drive the market forward. This problem is compounded by the fact that organizations sharing a common platform need to all make adjustments at the same time as Keystone. In other words, organizations operating in a platform ecosystem can only move as fast as the Keystone, which may be slow and arduous due to its large size and market share.

Less Consumer Choice

Another potential drawback of platform ecosystems and the resulting concentrated industries that are associated with these ecosystems is that consumer choice can be limited. Due to the numerous barriers to entry that are constructed by platform ecosystems, only a small number of organizations are truly competitive within the industry. As a result, consumers can potentially suffer from the concentration of the ecosystem industries, because it limits their choice of products to satisfy their needs. For example, if individuals need to purchase a cell phone, they are able to choose from only a handful of network providers to make the phone work. This may negatively affect consumers, because since these large organizations are less able to successfully adapt their offerings to satisfy changing consumer’s needs, individuals may find it difficult to find products or services that adequately satisfy their needs and wants. As a result, in order to satisfy needs associated with the need for communication (network providers and cell phone software), entertainment (social media sites, video game consoles, and Mp3 players), or sustenance (Walmart), consumers may be forced to choose the lesser of two evils rather than the product or service that satisfies their needs optimally.

Collusion and Consumers

Lastly, another major drawback of oligopolistic industries is the potential for collusion amongst the small number of firms that dominate the industry. Generally, when oligopolies collude with one another, they do so in order to keep prices artificially high in order to realize more substantial profits and cement their positions as industry leaders. This collusion either takes that form of colluding to directly keep prices artificially high or colluding to limit the output of their products or services in order to accomplish the same goal.

When examining these platform ecosystem and Keystone organizations, there is evidence that collusion can and has potentially occurred within and between these various ecosystems. An example of covert collusion that negatively impacted Keystone organizations’ employees, rather than consumers, can be seen in recent events. For example, in 2014, a class action lawsuit of 64,000 employees was filed against companies, such as Google, Apple, Intel, and Adobe, for engaging in anti-competitive behaviors.[27] The lawsuit alleges that these four companies formed an agreement with one another to begin implementing and enforcing anti-poaching practices.[28] The four companies mutually agreed that they would cease efforts to attempt to hire one another’s key employees.[29] As a result of this practice, 64,000 programmers are seeking billions of dollars in compensatory damages, because they argue that these anti-poaching practices resulted in their wages being suppressed and kept at artificially low levels.[30] By April 2014, the four organizations agreed to a settlement.[31] As this example illustrates, the potential for anti-competitive behavior and collusion not only exists within ecosystems, but also across ecosystems and Keystone leaders, and has the potential to not only negatively impact consumers, but also many other stakeholders of these organizations as well.

Conclusion and Implications

The goal of this article is to draw attention to some of the potential damaging effects business ecosystems can have on innovation and consumer choice. A secondary goal is to enhance awareness of the potential for oligopolies to develop in these markets, where a few large firms dominate the industry. Because of this, it is incumbent upon business leaders to pay careful attention to how reliance on complementary products and services may affect their ability to adapt to changing customer demands. If a company is attempting to develop pioneering innovations as a market leader, they may have more success by developing their own processes and platforms rather than waiting for Keystone organizations to move. As competition becomes more global in nature, companies are facing increased threats from ecosystems that span many different nations.[32] These threats may reshape the business environment in new and unforeseen ways. Although there are many advantages associated with creating value by working together, business leaders should be mindful of how the ecosystem they operate in may be affecting their ability to innovate and compete in the global market.