How to Position Your Company for Future Success: The Case of IBM

Future-Proof Your Business: Understanding Profitability Shifts in Evolving Industries

The article “Skate to Where the Money Will Be” by Clayton Christensen, Michael Raynor, and Matthew Verlinden, published in the Harvard Business Review, explores strategic decisions companies face in evolving industries. It dives into how companies can predict where future profitability will lie in their industry’s value chain👉 A series of activities that create and deliver value in a product for end-users. and how they can position themselves to capture these profits. The authors draw on the concept of disruptive technologies and the evolution of industry value chains to provide insights into strategic planning.

Introduction to Strategic Challenges

Companies frequently face significant challenges in predicting where future profits will emerge within their industry. A notable example of this struggle is IBM’s decision to outsource its operating system and processor chips in the early 1980s. This strategic move inadvertently paved the way for Intel and Microsoft to capture a substantial portion of the computer industry’s profits. IBM’s mistake underscores the complexity of identifying core competencies and forecasting future profitability. By outsourcing critical components, companies risk👉 The probability of adverse outcomes due to uncertainty in future events. losing control over potential profit centres, as seen in the rise of Intel and Microsoft. This scenario highlights the importance of understanding industry dynamics and making informed strategic decisions to maintain competitive advantage.

The difficulty in predicting future profitability is further complicated by the rapid evolution of industries. As markets mature, the sources of profitability often shift from integrated product manufacturers to suppliers of critical components. This transition requires companies to reassess their core competencies and strategic focus. For instance, in the early stages of an industry, companies may benefit from vertical integration to ensure product performance. However, as products become more modular and standardized, companies can outsource non-core components to focus on higher-margin activities like design and distribution. Effective strategic planning involves recognizing these shifts and adapting business models to align with emerging profit centres, thereby ensuring long-term success and profitability.

The Role of Disruptive Technologies

The concept of disruptive technologies plays a pivotal role in understanding the dynamics of industry evolution. Disruptive technologies often arise when established companies’ technological advancements exceed the needs of their current customers. This creates a gap that new entrants can exploit by offering simpler, more affordable solutions that meet the needs of a different market segment. The model of disruptive technologies helps predict where industry changes are likely to occur and where new competition👉 Rivalry between entities striving for a shared goal or limited resource. will emerge. It highlights how established companies, focused on sustaining innovations that improve existing products, may overlook opportunities for disruptive innovations that could redefine their industry.

However, the pursuit of disruptive technologies also poses a strategic challenge for companies. In their quest to improve efficiency and focus on core competencies, companies often outsource critical components that could become future profit centres. This outsourcing can inadvertently create new competitors who specialize in these components and eventually capture significant market share. The phenomenon is evident in how companies like Intel and Microsoft rose to prominence by supplying essential components to the PC industry, components that were initially outsourced by other companies. Understanding the role of disruptive technologies and the risks associated with outsourcing critical components is crucial for companies seeking to maintain their competitive edge and capitalize on emerging opportunities in their industry.

Stages of Industry Evolution

Industries evolve through distinct stages, each requiring different competitive strategies:

• Early Stage: Product Performance
  In the early days of an industry, companies compete based on product performance. Products are not yet good enough for mainstream customers, so companies focus on improving functionality. This stage requires integrated, proprietary architectures to achieve high performance. Companies like IBM in the mainframe era and General Motors in the early automotive industry dominated their markets by being highly integrated.
• Maturation Stage: Convenience and Customization
  As technology improves and products meet mainstream customers’ needs, companies shift to competing on convenience, customization, price, and flexibility. Modular architectures become more prevalent, allowing for faster product development and customization. This shift enables non-integrated companies to thrive by outsourcing components and focusing on assembly and distribution. Dell’s success in the 1990s is a prime example, as it customized computers using outsourced subsystems.

Integration vs. Disintegration

The transition from integrated to modular architectures marks a significant shift in industry structure:

• Integration: When products are not yet good enough, integration is crucial. Companies must design and manufacture interdependent components to achieve high performance. This integration provides strong competitive advantages, as seen in IBM’s dominance of the mainframe market.
• Disintegration: As products become more than good enough for mainstream customers, modular architectures emerge. This allows companies to outsource components and focus on assembly and customization. The computer industry’s shift from integrated companies like IBM to modular specialists like Dell illustrates this transition.

Interfaces, Modular Designs, and Modular Innovation

Effective outsourcing of components is a strategic decision that requires careful consideration of several key conditions. By understanding these conditions, companies can ensure that outsourcing enhances their operations rather than compromising them.

• Specifiability: Managers must know what attributes of the component are crucial
  Specifiability is essential because it allows managers to clearly define the requirements of the outsourced components. This clarity ensures that suppliers understand what is expected of them, reducing the risk of miscommunication or misaligned product features. When managers can specify critical attributes, they can better negotiate contracts and monitor supplier performance, ensuring that outsourced components meet the company’s needs.
• Verifiability: They must be able to measure these attributes
  Verifiability is crucial for ensuring that outsourced components meet the specified requirements. By being able to measure these attributes, companies can verify that suppliers are delivering components that meet quality and performance standards. This ability to measure also facilitates quality control processes, allowing companies to maintain consistency across their products even when components are sourced from external suppliers.
• Predictability: There should be no unpredictable interdependencies between components.
  Predictability is vital for maintaining the reliability and performance of products that incorporate outsourced components. When there are no unpredictable interdependencies, companies can confidently integrate outsourced components into their products without worrying about unforeseen interactions that might compromise product functionality. This predictability also simplifies the design and testing processes, as engineers can rely on consistent behavior from the outsourced components, thereby reducing development time and costs.

When these conditions are met, modular designs can facilitate efficient outsourcing. However, when product performance is not yet good enough, these conditions are often not satisfied, making integration more advantageous.

Profitability Shifts

As industries evolve, the dynamics of profitability undergo significant changes, impacting where and how companies generate their revenues. Understanding these shifts is crucial for businesses seeking to maintain their competitive edge and capitalize on emerging opportunities.

• Early Stage: Integrated companies designing and assembling end-use products capture most profits due to differentiation and economies of scale.
  In the early stages of an industry, integrated companies that design and assemble end-use products typically capture the majority of profits. This is due to their ability to differentiate their products and achieve economies of scale through vertical integration, which allows them to control all aspects of production. By maintaining control over the entire value chain, these companies can optimize their operations, reduce costs, and enhance product performance, thereby securing a strong market position.
• Maturation Stage: As products become modular, profitability shifts to suppliers of critical subsystems.
  As industries mature and products become more modular, the sources of profitability shift from integrated manufacturers to suppliers of critical subsystems. This shift occurs because modular designs allow companies to outsource non-core components, focusing instead on high-margin activities like design and distribution. Suppliers of essential components, such as Intel and Microsoft in the PC industry, can command high prices and achieve significant profitability due to their strategic position in the supply chain, often becoming more profitable than the companies assembling the final products.

Strategic Errors

Strategic errors in outsourcing often arise when companies outsource components that could potentially become future profit centres. This mistake is frequently driven by investor pressure to enhance return on assets (ROA). In an effort to improve financial metrics, companies may divest asset-intensive units, focusing instead on modular assembly and design. However, this strategy can backfire when these outsourced components become highly profitable in the hands of specialized suppliers. For instance, companies like Intel and Microsoft have become incredibly successful by supplying critical components to the PC industry, components that were initially outsourced by other companies. This scenario highlights the importance of carefully evaluating which components are core to a company’s competitive advantage and future profitability.

The pressure to improve ROA can lead companies to overlook the long-term implications of outsourcing critical components. By shedding asset-intensive operations, companies aim to reduce their asset base and increase efficiency, but they may inadvertently create new competitors who specialize in these components. Studies have shown that companies are more likely to fail when they outsource components critical to their competitive position, as this can lead to loss of control over key technologies and increased dependency on suppliers2. Effective strategic planning requires balancing short-term financial goals with long-term strategic considerations, ensuring that companies retain control over components that are crucial to their future success. This involves a nuanced understanding of which assets are truly core and should be managed internally versus those that can be safely outsourced to specialized providers.

Conclusion

The article provides a framework for understanding how industries evolve and where future profits will be made. It emphasizes the importance of recognizing the stage of industry development and positioning the company accordingly. By understanding these dynamics, executives can make informed decisions about what to integrate and what to outsource, ultimately “skating to where the money will be” in their industry’s future.

Key Takeaways

• Industry Evolution: Industries transition from competing on product performance to convenience and customization. As industries evolve, companies shift their competitive focus from enhancing product performance to offering convenience and customization, which better aligns with mature market demands. This transition reflects a change in customer needs, where products are no longer differentiated solely by their technical capabilities but by how easily they can be tailored to individual preferences.
• Integration vs. Modularization: Integration is crucial when products are not yet good enough, while modularization becomes advantageous as products mature. In the early stages of an industry, integration is essential for achieving high product performance, as it allows companies to control all aspects of design and manufacturing. However, as products mature and become modular, companies can outsource non-core components, focusing on assembly and customization, which enhances flexibility and reduces costs.
• Profitability Shifts: Profitability moves from end-product manufacturers to suppliers of critical components as industries mature. As industries mature, the sources of profitability often shift from companies that assemble end-use products to those that supply critical components, such as Intel and Microsoft in the PC industry. This shift occurs because suppliers of essential components can command higher prices and achieve greater profitability due to their strategic position in the supply chain.
• Strategic Planning: Companies must anticipate these shifts to position themselves for future profitability. Effective strategic planning involves anticipating the shifts in industry dynamics and profitability to ensure that companies are well-positioned for future success. By understanding these trends, executives can make informed decisions about what to integrate, what to outsource, and how to allocate resources to maximize profitability in a rapidly changing business environment.

By applying these insights, companies can better navigate the complexities of evolving industries and make strategic decisions that align with future profit centres.