2. Commodity Markets Defined

Where are the growth engines for businesses today? How do firms avoid the commoditization that is occurring across so many industries? The answer may surprise you: Commoditization forces the growth engine. It is the ally of the growth business, though it will remain the enemy of the fixed structure company. It's time to reinvent your organization.

Here are the modern realities of business:

Profitable growth is hard

It has always been difficult to build profitable growth and even more difficult to sustain a profitable growth path. Only a tiny fraction of firms have ever succeeded in doing so. The pragmatic reality is that most long-term business growth barely keeps up with economic growth, and revenue increases hover around the national inflation rate.

And getting exponentially harder

Even if you're managing to keep up with the ever-increasing pace of competition, it is getting exponentially harder to grow profitably as the interaction of deregulation, globalization, and Internet-based technology fuels more and more competitive intensity. This is not a linear evolution but a compounded and accelerating steep curve. Each of these critical forces fuels competition; globalization of manufacturing and labor, Internet-enabled electronic commerce, Internet-enabled supply chain management, and the deregulation of telecommunications are obvious instances.

When these changes interact and feed on each other, entire competitive ecosystems lose their traditional identity and levers of control. At this point, there are very few industries that are not being reshaped by these changes, forced through the stages of creative destruction. Telecommunications, travel services, consumer electronics, auto manufacturing, computers, banking, software, and the music business have all been reinvented in the last decade. In some instances, deregulation is the pivot; telecommunications is the most obvious instance. In others, it is globalization, as in consumer electronics and auto manufacturing. In still others, the Internet subverts the status quo; travel services are an example. Once any of these forces gains critical mass, the others come into play, creating a new level of competitive intensity that accelerates. Almost inevitably, the three forces converge at some point; the Internet is in many ways part of the globalization of labor supply and in itself a form of "deregulation" in its removal of protective barriers to entry, control of channels, and constraints on the flow of information on prices and services.

The Ecosystem Impact

The impact of these forces on the ecosystem is inevitable: overcapacity, customer power (which translates fairly immediately to price competition), and then componentization as a necessary response and commoditization as the inevitable outcome. These all interact, too. They feed back into the environment of globalization, deregulation, and technology; this is demonstrated by the competitive intensity of the consumer electronics ecosystem—manufacturers, supply chain services, contract manufacturers, designers, retailers, electronic commerce portals, and fabrication plant giants. This used to be a high-tech industry. Now, it is a commodity ecosystem characterized by overcapacity, customer power, componentization, and thus constantly shrinking margins and price cuts.

The interaction of all these new competitive changes also produces a system of constant innovation in technology, methods, and services. Because these are rapidly componentized and incorporated into the products of all the main players in the mass market, the innovations themselves end up pushing these companies toward commoditization. Digital cameras, computer storage, mobile phones, and PDAs exemplify the breakneck pace of innovation and commoditization.

As competition intensifies, overcapacity grows. Technology generates competition; so does deregulation. Globalization adds to it. For example, China and India are fueling competition around the world by offering low-cost services and products. Customer power increases as a direct result of deregulation, compounded by the degree to which the Internet provides customers with information and new choices. When customer power is constrained by regulation, options are limited because of market protectionism, and information on services and prices carefully protect providers, the customer ends up at the end of the industry value "chains." When customers learn how to pick and choose, they go for the best deal and increasingly know where to find it. Ecosystems reshaped by the deregulation–globalization–Internet combination of forces have seen prices drop at least 20 percent over a five-year period; telecommunications, air fares, consumer electronics, and, more recently, prescription drugs, are leading examples.

The Ecosystem Response

The response to increased competitive intensity is componentization: the move to interchangeable parts. As carmakers, PC hardware product brands, and financial service firms respond to competitive intensity, they focus on cost efficiency. They abandon their in-house manufacturing and proprietary parts and seek out low-cost suppliers who can provide off-the-shelf resources. These resources increasingly also include off-the-shelf processes such as customer service, back-office functions, distribution, and supply chain management. The Internet becomes the enabling vehicle for collaboration in componentized engineering, design, and research.

For all this to be efficiently managed, low cost, quality, and speed are essential. Companies in the mainstream of the ecosystem have no choice but to move toward standardized interfaces: shared agreements, some specific and some implicit, on how components link together. For instance, customers can now add more memory to their PC without going through the manufacturer: They walk into a store like Best Buy or run a search on Google and quickly pick their best option. The component providers offer different prices and vary the details of their products, but their components interface directly to the PC.

Componentization Drives Commoditization

Low-cost producers look for advantages of scale, and specialist players tailor their strategies to standardized interfaces. Going back to the example of PC memory, how many of you have heard of Kingston? Look at the ads in your newspaper and you'll see that merchants now emphasize low-price components (including Kingston, just one of the commodity players). From a commoditization perspective, contract manufacturers like Flextronics are why your printer, PDA, or digital camera cost less than they did six months ago; they are all built on componentized parts assembled through standardized interfaces to create branded products. HP is among the best-known printer brands, yet it has outsourced all manufacturing, and repairs are handled exclusively by UPS.

When you call a company for customer service or technical assistance, are you reaching a site in Ireland, India, or Omaha? Call centers are now viewed as a business component. So, too, are more and more manufacturing, back office, and other previously "in-house" capabilities. How many hospital patients know that their X-rays and MRIs are sent directly to Makati in the Philippines? When they buy an "American" or "Japanese" car, how many of the standard parts were made in the home country? Do they need to know?

Competitive intensity creates ecosystem impact, and commoditization is the inevitable outcome. There will always be a space for the innovator to invent something truly "new." But commoditization catches up quickly. "New" quickly becomes "standard," which soon becomes "special price," which then begets free printer, installation, or two for the price of one. Mortgages, computer storage, hotel rooms, medications, airplane tickets, mobile phone services.... The list is long, and no ecosystem is immune to this commoditization drift.

Commodity Heaven and Hell

Commodity hell for producers is commodity heaven for customers. They pick channels, providers, and products on whatever basis they want, in complete control of the transaction. Customers may not necessarily choose on the basis of price; the key is that they have choices. In some instances, the choice favors design, or fashion is the deciding factor, and they will pay a little more for the same commodity functionality of, say, a printer or a mobile phone. They will in other instances favor a brand for a different reason.

In many cases, the owner of the brand may have little to do with the production, delivery, and servicing of the goods. One illustrative example is Hong Kong-based TAL Group, the coordinator of a value web that retailers like JC Penney and Lands' End use to produce customized dress shirts. JC Penney takes the order in the store and TAL does the rest, synchronizing hundreds of raw materials providers, factories, and shippers to deliver as small an order as one shirt to JC Penney or even direct to the customer with the appropriate logo sewn on. TAL accounts for one in eight of all the dress shirts sold in the United States, but it is doubtful that their purchasers have ever heard of the firm. The customer gets a customized shirt at a commodity price. TAL is an instance of how coordination of value webs can help firms escape from commodity hell. They offer a services web that firms like JC Penney utilize as an extension of their value chain to create a new degree of coordination.

The General Response: Tighten Control

The typical ecosystem reaction to commodity hell is control-centered: Try to get on top of the changes. This "tighten control" strategy centers on cost cutting, outsourcing, efficiency, mergers and acquisitions, and restructuring. There is a truly hellish catch here, though: Control fuels the very forces that created the need for control in the first place, creating a terrible feedback loop (as depicted in Figure 2.1).

Figure 2.1 Commoditization cycle.

Welcome to the Cruel Economy.

The Alternative: Let Go to Grow

There is an alternative response to commodity hell: an on demand business platform that we characterize as "Let Go to Grow." The winners in creating and sustaining growth in the era of commoditization will profit and thrive by putting the pieces together in new ways and by changing their traditional thinking.

The term "platform" is used in many contexts, but it is fundamentally a foundation, launch pad, and set of standardized interfaces. A business platform is essentially a set of business capabilities on which other capabilities can be built, linked, and expanded to meet the pace of customer demand and relationship needs. In the technology world, a platform is a set of technologies on which other technologies are built. Windows is a software platform on which thousands of applications are built and linked. Although Microsoft was able to leverage Windows through their market might, it appears that they are seeing Linux, backed by IBM and a number of other players, as an increasing threat. The Linux platform provides similar capabilities but in a more open development arena using open standards that have, through the inevitable forces described in this book, enabled Linux to take a significant foothold. Similarly, Intel's individual products constitute the core hardware platform of the PC ecosystem. In the car industry, standardized manufacturing platforms have replaced independent model designs and facilitated reuse of components, global coordination of design and production. In financial services, the credit card is a platform on which entirely new payment services have been developed. Through its links to a wide range of processing capabilities, the credit card has also been extended into non-credit areas. For example, credit cards now enable automated check-in at airports; the airline uses this standardized identification in a completely non-financial manner.

The Business Platform

A business platform has three distinct elements:

• Governance rules and roles—Components are individual; a platform is designed for coordination and collaboration. Successful platforms require policies with teeth—governance rules—and allocation of authority and responsibility that ensures enterprise coordination plus localized application and innovation.
• Blueprints and interface standards—The degree of linkage, extension, and collaboration rests on technology standards, industry practices, and process interfaces.
• Integration capabilities—A platform coordinates many players in value webs and must be able to grow in reach, range, and robustness. Reach refers to the link with customers and partners; range, to the variety of roles a platform can play and services it can offer or support; robustness, to end-to-end quality and reliability.

The Air Traffic Control system is a splendid illustration of these three platform elements. Governance rules and roles are the glue of the ATC: its regulatory framework. The individual passenger is largely unaware that components, generating flight operations, check-in procedures, terminal operations, and facilities rely on these rules. ATC includes many blueprints to ensure coordination of components. The entire system must manage 5,000 planes in U.S. air space at any one time and synchronize all the many interactions this involves.

Let Go To Grow is an executive handbook for defining the business equivalent of the Air Traffic Control system: your firm's business platform. Agility is the key to profitable growth in commodity hell. It breaks the negative feedback loop of the "tighten control" strategy and creates options for growth.

We title our book Let Go To Grow because letting go is the key management and cultural shift necessary to grow, to become a firm that combines speed, flexibility, adaptability, coordination, collaboration, and innovation. The role of the business platform is to enable growth, and the role of the corporate culture is to exploit the opportunities that the platform enables.

We base our analysis on an in-depth review of firms that have successfully made the shift to become agile firms—our work is not at all hypothetical. Though these leaders are very different in size, industry, strategy, and other ecosystem demographics, they show the same overall drive for growth. They accept commoditization and use their platform as an ally. Wal-Mart and Dell sell commodity goods, and their supply chains are the coordination of components. GE's governance rules componentize its back-office and administrative processes across its many diverse units. This GE standardization creates, rather than blocks, innovations in organizational design and location.

Growth leaders let go of the traditional value chain and build relationships everywhere, relying on partners for capabilities that used to be protected as "core" and kept in-house. They turn outsourcing of functions into insourcing of capabilities, drawing on collaborations in design, engineering, and distribution that they bring in-house even though outside parties handle them.

They grow through others' growth. UPS handles close to two-thirds of all online e-commerce transactions. Its ads speak of its "synchronizing" its customers' entire logistics from warehousing to shipping to inventory management to financing. UPS gives up control to its customers in order to build growth, and in doing so, it fuels its partners' profitable growth by providing logistical expertise, scale, and systems without the partner firm needing to make heavy investments of capital, organization, and people.

Growth leaders make the truisms about commitment to the customer a reality. They give up control of information and decision-making to the customer and facilitate customer innovation via their own platform. Amazon's platform synchronizes a set of components that even competitors like Borders use. Some 35,000 e-commerce technology developers use the Amazon technology platform as they want. Amazon associates are any person, company, club, public sector group, or school anywhere that would like to earn commissions through connecting their customers to Amazon. FedEx gives customers complete control of their interactions with the company—FedEx gives up control to gain collaboration and growth. eBay is explicitly, not accidentally, driven by its customers; eBay grows and grows as a result.

Above all, business platform leaders are leaders because top management understands the platform issues. That is of critical importance to moving from Component hell into platform-driven growth. Platforms rest above all on governance rules. Spot the component/commoditization trends early and take charge of change.

Commoditization: Enemy or Opportunity?

Commoditization is a scary word for most executives. Given that we are living in an era where commoditization of entire industries is the main trend, the term will inevitably become even scarier, and commoditization will force many companies into a struggle for survival. The automotive business is one example of an industry where every company used to be a confederation of separate design and production facilities, manufacturing specifications, and car models built of entirely different parts. Now, survival rests on componentization: shared designs and manufacturing production lines, tight coordination of multiple supply chain relationships, standard parts, and skilled use of specialist suppliers.

Many players in this ecosystem are struggling. The secret to making commoditization an ally is a statement by an executive in Timken, the century-old maker of bearings: "There are factories around the world that are focusing on one simple product, and they're killing us on price."¹ The key now, he says, is to surround the company's basic product with additional components in order to provide customers with exactly what they want.

The On Demand Business has a platform in place—policies, governance rules, and process and technology blueprints—to exploit componentization as an integrative opportunity. Many automakers and parts suppliers have not been able to create such a platform, however. They get all the disadvantages of componentization and see few of its benefits. Parts makers see prices fall and fall. Carmakers see platform leaders ahead of them in time to market, manufacturing cost and flexibility, and supply chain efficiency. The business platform leaders, most obviously Toyota, push componentization—and hence commoditization—of their suppliers farther and faster. They push innovation and end-to-end business integration equally farther and faster.

Large companies in all industries are moving to exploit the advantages of componentization wherever possible. Many of them were operating on the very opposite principle of componentization—over-reliance on in-house capabilities in every area of business. Procter & Gamble is an example of a company making the shift. P&G has opened up its boundaries and componentized many in-house operations, giving them added flexibility and options. Componentization has also affected how P&G operates as a supplier, too: Wal-Mart has handed over inventory management in its stores to P&G and made it the "category captain"² for all detergents sold at Wal-Mart regardless of manufacturer.³

These are outside relationships to be coordinated rather than operations to be run internally.

In the pharmaceutical industry, research and development is being componentized through linkages to outside teams, patent licensing, and project outsourcing. Research hospitals such as St. Jude in Memphis, Tennessee, now have their own small manufacturing plant to take their experimental products into small-scale production. They then invite large pharmaceutical firms to take over full production and marketing. Biocon in India has 300 research scientists working on an outsourcing contractual basis with such firms as Pfizer. R&D is rapidly moving from an in-house preserve to componentized collaboration—a value web of synchronized relationships.

Competitive necessity is forcing this opening up of boundaries. Componentization is the logical result of pressures to reduce costs, simplify and standardize processes, and speed up operations. Overcapacity, global competition, and technology combine to fuel the move toward standardization of how components link to each other. The individual parts may be different, but they can be assembled through the same interfaces. Buyers then look to obtain the most cost-effective elements, the ones that offer the best quality or those that can be used in multiple products. Large buyers are in a position to make high demands, especially on price, because the interface enables them to switch to another provider of a component without any retooling or manufacturing down time.

Componentization decomposes traditional value chains. Instead of relying on in-house resources, companies now increasingly look to use components from a wide range of suppliers and allies. They rationalize internal operations, with outsourcing often a decision made on economic necessity. In the auto industry, shared manufacturing platforms replace independent design and production facilities. In the consumer electronics and personal computer markets, the leading brands focus their skills on design even though they outsource all manufacturing to a company that assembles their product out of standard components.

The pressures of commoditization increase componentization in all areas. Many of the recent innovations of "old" economy leaders, such as GE and Toyota, and "new" economy growth firms, like eBay and Amazon, are the result of their leaders' aggressive focus on componentizing internal processes so that they can be standardized, reused across the company, and the basis for entirely new organizational structures, customer services, and partnerships. These firms innovate in supply chain management, fine-tuning their operations to a degree that every major relationship requires on demand synchronization of components, with their quality and service demands ever-increasing, but not the prices they pay.

In the information technology field, componentization is transforming the entire industry. Historically, just about every key element of IT was "proprietary"; there were few interchangeable parts and each major software, hardware, and telecommunications provider had its own closed systems. This proprietary era is rapidly coming if not to a close then at least to a standstill. IT is becoming fully componentized through standardized interfaces: tools and services for linking documents, applications, and data items regardless of their technology base. Microsoft and Apple are the two remaining proprietary players in an industry where all the key acronyms mean "components": Linux, XML, USB, and Web Services, to name just a few.

IBM made a shift in the same direction as P&G several years ago, toward increased reliance on open standards in lieu of proprietary systems and products. Proprietary interfaces are the past of IT and only in a few cases—as with Windows—are still a major factor in the present. Standardized open interfaces are IT's future. Although this is commoditizing many previously highly paid IT skills through global sourcing, the componentization that it brings is transforming the costs, speed, quality, and flexibility of IT—at last! One of the most powerful impacts of IT componentization is its "on demand" capabilities; it has enabled new linkages to instantly coordinate global value web operations.

The Business Platform As Growth Engine

Some firms extend the marketable value of their components and make them an integral part of value webs. UPS and FedEx offer their logistics components to enable new capabilities in customer service and supply chain management. Referring back to the Timken executive's comment about surrounding basic products with additional components, FedEx and UPS surround their basic shipping with warehousing, management of repairs, freight consolidation, and many other services. What makes these "components" is that they are interchangeable with clients' own services and systems. UPS and FedEx are a portfolio of assembly blocks that customers can add to their own business platforms.

Such linkable components become multidimensional capabilities that are of value in many contexts and partnerships. They can be the basis for profitable business expansion, because componentization transforms the dynamics and costs of growth. This approach also opens up new options for sourcing because they offer variable costs and on demand services instead of fixed capital investment, with all its risks and lead times. It creates opportunities to make components the building blocks of new value webs—cross-organizational complexes such as the global coordination machine that TAL has built to synchronize clothes manufacturing with hundreds of partners, and the automotive contract manufacturing company Magna to which BMW has outsourced the entire production of its X3 series of SUVs.

Amazon reuses its components to build profitable relationships with any web site owner, thousands of independent software developers, several of its competitors, and many retailers. Amazon is built on its business platform. The power of componentization is illustrated by the personal announcement in April 2004 by its Chairman, Jeff Bezos, that Amazon was entering the jewelry market. He stated that he could buy a jewel wholesale for $500 and sell it online, with guarantees, a high-quality product for $575. Tiffany and Zales sell the same stone for $1,000. Amazon has the technology platform in place, the catalog management system, ordering and order fulfillment, and shipping—a value web component provided by UPS and the U.S. Postal Service—to allow this dramatic improvement in efficiency.⁴

There is a consistent pattern in the strategies of leaders like Jeff Bezos of Amazon, Jeff Immelt of GE, Meg Whitman of eBay, Michael Dell of Dell Computer, Fred Smith of FedEx, Sam Palmisano of IBM, and many smaller firms. It is the commitment to the business platform as the edge in a component world. Without that commitment at the top, governance is missing and the company ends up as the sum of its (often) commoditizing parts. As those parts lose value, so does the firm.

Making the Platform a Success

Componentization and commoditization are your enemy unless you have the platform to turn a commodity business into a growth engine. That takes speed, flexibility, adaptability, coordination, collaboration, innovation, and cost optionality:

• Speed of deployment—Move fast: reuse a component, link it to a business partner, sell it as a service, source it as a new capability.
• Flexibility—Move nimbly: add components from partners, extend your value webs, fine-tune your supply chain.
• Adaptability—Move in good time: source new components for new situations and business opportunities.
• Coordination—Move together: link components via the platform; use IT as the coordination and synchronization base for complex processes and webs.
• Collaboration—Create together: build new capabilities for yourself and partners via existing components and as part of new services and relationships.
• Innovation—Invent opportunistically: continuously look to extend and create value webs, innovate on behalf of the customer.
• Cost optionality—Earn as you go and grow: turn long lead time, high-risk capital investments and fixed costs into variable costs, scale on demand.

Components plus a platform gives you options. Options drive growth opportunity. Components without a platform equal.... Well, not very much for your company's future options!

Future business historians may view componentization as the key to growth in a new century. Their response to the commoditizing impact of componentization is akin to judo, not boxing. In judo, you stop fighting your opponent and go with the flow. Leverage componentization for your advantage, not your opponent's. The challenge is to use components to not get stuck with just components.

What's Left When Everything Is Just a Component?

Logically, if an entire industry ends up componentized, then the product must become just a commodity. In many instances, that clearly is the case. The personal computer industry is an obvious example. It moved from "high tech" to commodity in just a few years. It is now a component business. But no matter how commoditized the industry, there is always a space for effective differentiation, as demonstrated by the ongoing success of Apple Computer.

Others find their space in the component economy by using their business platform to extend the capabilities of customers and partners. Auto parts manufacturer, American Axle and Manufacturing, is, in its founder's words, "transforming Detroit into a low-cost country"⁵ (making a $170 million profit on $3.7 billion in sales in 2003). It found its place in GM's manufacturing webs and augments component parts with its IT platform that coordinates quality management and metrics. Magna allows BMW to totally outsource entire model lines, as Magna also has for Saab and Mercedes, through its coordination of planning and design and its expertise in production engineering.

In the equally distressed electronics parts market, Flextronics "bundles" components on behalf of major computer "manufacturers," helping them customize their products. Flextronics provides standard outsourcing for brand-name consumer electronics manufacturers, and its revenues are bigger than most of theirs; its edge is its reliability and ability to operate with an overhead of only 2–4 percent. These relationships are platform to platform, not transaction buyer to seller.

Componentized products, processes, and services make design and supply chain management their growth and profit advantage. If you walk through a store like Best Buy or Circuit City, your choice of a computer printer or digital camera is likely to be based on brand, but you can be almost certain that the vendor outsourced the manufacturing and product distribution. HP is best known for its printers. It designs and markets them, but makes none of them—manufacturing is completely outsourced.

The New Service Providers in the Component Economy

Let Go To Grow is for corporate executives and their advisers who must shape their companies' strategic positioning. Our focus is thus mostly on how to build flexibility. Part of that rests on finding such suppliers and partners as Magna, UPS, Flextronics, IBM, and other on demand service providers, whether they are to be found in-house or at third-party firms.

The chairman of Flextronic boasts that one key capability his firm's platform offers is the ability to move production of a model from, say, China to Mexico, in three weeks. This makes them rather different in profile from their customers. They rely on scale and absorb much of the fixed cost and risks of operations.

For example, BMW orders X3 production from Magna on an as-needed, pay-on demand basis. Magna saves BMW from investing a billion dollars in a new facility. But Magna has to spend its own money on building capacity. In the IT field, more and more services are being offered on the same basis: on demand and with variable cost. The providers must have many of the characteristics of utilities: scale, reliability, financial capital strength, and a strong reputation. If that were all they had, however, they'd still be trapped in the commodity economy. They would be just offering components on a price basis. Instead, the leaders are all building strong business platforms, emphasizing their integration rather than their individual component offerings, and adopting standardized interfaces.

IBM's business strategy is built around this "on demand" concept. Components and on demand are obviously interrelated; one implies the other. But the key to making them powerful forces for growth is the business platform: linking user to supplier platform and adding more and more dimensions of value beyond the transaction price of the component.

Summary

Growth is difficult and there's no reason to think that it's going to get any easier to produce profitable growth in your market segment, regardless of what it is. Among the forces causing this are deregulation, globalization, and the pervasiveness of the Internet and high-speed global communications. These are producing constant innovation while simultaneously forcing commoditization. The response? Componentization, and it's that componentization that makes value webs such a powerful and critical part of your future business strategy.