The Keystone Advantage
What the New Dynamics of Business Ecosystems
Mean for Strategy, Innovation, and Sustainability
Marco Iansiti and Roy Levine
Chapter One – Rethinking Networks
“Strategy is becoming, to an increasing extent, the art of managing assets that one does not
own.” Power firms such as Wal-Mart and Microsoft have achieved success by determining “how
to create, manage, and evolve an incredibly powerful business ecosystem.” For Wal-Mart,
advantage was gained by gathering “consumer information to coordinate the distributed assets of
its vast network of suppliers. You can almost think of it as a single enormous operation, made up
of thousands of companies.” Wal-Mart chose to share demand information collected in real time
with its supplier network. Microsoft, on the other hand, “focused on designing programming tools
and technologies that were used by thousands of organizations and millions of developers.”
History reminds us that Microsoft’s first product was not an operating system, but a programming
language – “effectively a tool that enabled developers to more easily create software that would
run on a large number of machines.”
Both firms “acted as a crucial hub in a vast and diverse business ecosystem, offering platforms
on which others could build.” A symbiotic relationship exists between the firms that built the
networks and the firms that “made investments in leveraging these platforms and began to
depend on them for their success.” The success of the ecosystem is build on “a number of
critical factors.” First of all, performance of the network of business partners is linked. Secondly,
the hub firm must work “hard to organize the behavior of these business partners, creating
opportunity for growth and innovation.” Finally, hub firms are “only strong if this business
community large, healthy, and growing.” The ecosystem “only wins if they continue to sustain the
collective health of their vast networks of business partners.” The fate of the hub is “share with
that of the other members of their business networks.” These hub firms, in fact, play “the role of
keystone in their perspective ecosystems. Drawn from biology, the term describes a pattern of
behavior that improves the performance of an ecosystem and, in doing so, improves individual
performance.”
The pervasiveness of networks “is the result of an evolution in social, economic, political, and
technological systems that has stretched over the last few centuries.” The authors highlight the
Italian apparel network as an example of a network built around hubs that combine autonomy and
coordination to develop the robust power to survive “hundreds of years of technology and market
changes.” In the era of DuPont and Ford, “creating distributed business networks was too difficult
and costly, and the advantages of vertical integration dominated in most environments.” In the
era of networks, distributed networks serve as an alternative to the command and control of
vertical integration. The advent of business networks has created a new challenge.
No longer can managers focus merely “on the internal operations of the firm.” Now managers
must develop expertise in managing “the vast networks of firms” that comprise the ecosystem.
“Prevailing management theories all too often advise the operating manager to create small,
isolated units to fight problems and leverage opportunity. These theories have a difficult time
dealing with a huge, unfocused, unbounded, amorphous, and constantly evolving network like the
internet.” How does a manger “manage a network of business partners that is one thousand
times the size of the firm?” “When the Internet took off and business networks became
ubiquitous, our understanding of management and strategy simply did not keep up.” Managers
and leaders, according to the Iansiti and Levine thesis, must “develop a solid understanding of
how networks and key firms within them support or inhibit innovation, how they can enhance or
damage operational productivity and how they can provide healthy, sustainable environments for
the creation of new firms and products.”
As a consequence of a broad research effort, the authors determined that “more than any other
type of network, a biological ecosystem provides a powerful analogy for understanding a
business network.” A business ecosystem is “characterized by a large number of loosely
interconnected participants who depend on each other for their mutual effectiveness and
survival.” When the ecosystem is healthy, all of the individual species are able to thrive.
Ecosystems are often organized around “richly connected ‘hubs’ [that] can have profound effects
on the health of the entire network.” These hubs “take the form of active keystone whose
interests are aligned with those of the ecosystem as a whole and serve as critical regulators of
ecosystem health.” As a critical point of clarification, the authors communicate that they “are not
arguing that industries are ecosystems or even that it makes sense to organize them as if they
were, but that biological ecosystems can serve as a source of vivid and useful terminology as well
as provide specific and powerful insights into the different roles played by firms.” Additionally, the
research indicated “that almost all healthy business ecosystems were characterized by some kind
of keystone function.”
The implications for strategy are drawn “from biology and complexity theory.” The authors
“differentiate between a number of different strategic modes” – the keystone, dominator, and
niche strategies. “Keystone strategies shape and coordinate the ecosystem.” This is contrasted
with “dominator strategies, which attack the ecosystem, absorbing and integrating external assets
into internal operation. Niche strategies can be pursued by the much larger number of firms that
make up the bulk of the ecosystem. These firms emphasize differentiation by focusing on unique
capabilities and leveraging key assets provided by others.” Traditional strategy frameworks that
focus on internal competencies that overemphasize firm capabilities and fail to adequately
appreciate “the relationship between the firm and its external ecosystem.” The authors argue that
“firms will be distinguished by the way they manage the massive web of dependencies that is
created between them and the rest of the world.”
The book follows a very straightforward structure. The first section (The Ecosystem Framework)
introduces the ecosystem framework. The second section (Ecosystem Strategies) is a discussion
of the strategy implications of the ecosystem framework. The final section (Foundations for
Competition) “focuses on operating implications by discussing three foundations of competition in
a networked world.”
Section One – The Ecosystem Framework
Chapter Two – Shared Fate
We live in a “highly interconnected world.” As a government official warned shortly after the
September 11th attacks, “Everything’s hooked to everything.” “We live embedded in a system,
and, more than ever before, our fates depend upon its fate.” The authors reduce the scope of the
book from global interconnectedness to an attempt to evaluate the influence of networks on
business practice. A few questions are highlighted:
• “How can we as practitioners and managers act to take advantage of our
interconnectedness?”
• Because firms build products that are dynamically connected to other products and this
“shared fate” requires an “active and informed management, can we characterize the
kinds of management stances that exhibit this kind of informed approach?”
• “How can we avoid making mistakes that will damage the networks of which we are a
part?”
• “Are there specific actions we can take that enhance the health of our networks?”
• Can the approaches of ecosystem savvy firms be generalized and reproduced?
Biological systems offer a “better appreciation of what it means to be a part of a richly networked
system.” Interdependence drives stability, productivity, and creativity in biological systems. The
fate of one species is bound to the “fate of the entire network of other species in the ecosystem.”
“Each member of the ecosystem depends to some degree on the presence of every other for the
simple reason that they are adapted to each other’s presence. Essential inputs to the survival
and health of every member of an ecosystem are provided by the other members of the system.
Whereas removal or displacement of these members results in the loss of important food
sources, destruction of essential microhabitats, or loss of protection from a predator or
competitor, their continued presence sustains the health of the system and helps to shape and
maintain a system that provides benefits to the entire ecosystem.”
The computing sector is a “striking example” of this shared fate interconnectedness. Note the
specialization that exists in this sector. Many firms produce offerings that “have no value on their
own outside the context of the collective effort.” “The goal is no longer to lock out entire vertical
stacks with proprietary advantage, but to be the best in a chosen area of specialization.” The
interaction in the networked economy “is not along traditional industry boundaries.”
The apparel industry represents a “complex network of firms…ranging in size from single-person
operations to multibillion-dollar textile firms such as Levi Strauss & Co.” The garment industry “is
composed of four major segments: fiber producers, textile mills, apparel manufacturers and other
textile users, and apparel and other soft goods retailers. This network has evolved around Li &
Fung, “a hundred-year-old Hong Kong-based trading company.” This hub “customizes supply
chain services to fit the needs of individual retailers such as the Gap or the Limited.” Li & Fung
shifts resources to different members of the network in response to “changes in technology,
consumer preferences, or government regulation.” To perform this balancing and reallocation
function, Li & Fung must be careful not to extract too much value from its network.”
In the era of the 60’s, firms within the computing industry competed head-to-head for dominance
as vertically integrated, independent technology stacks. Eventually, these stacks “began to
disintegrate into the computer industry we know today. IBM set the pace by defining a “clear,
modular interface between software and hardware, which guaranteed compatibility between
models. This clear interface had an unintended but crucial effect – it set in motion a process to
fragment the industry into a wide variety of diverse organizations, each providing different
products and service components and focusing on different capabilities.” This gave birth to the
combination of Microsoft DOS and the IBM personal computer which in turn provided a platform
for a “vast number of software providers to design general-purpose applications that would run on
a wide variety of hardware combinations.”
Eventually, the industry “fragmented into a number of clusters of firms each supported by a
different type of computing platform. Each [platform] was in essence a separate ecosystem of
business partners, each including different component suppliers, system vendors, and software
developers (ISV’s). Each organization had a close affiliation with the ‘mother’ platform, which in
some cases became something akin to a religion for its devoted disciples. This naturally gave
rise to fierce competitiveness between platforms,” (e.g., Mac versus PC). This trend accelerated
with the development of “loosely coupled integration methodologies” and further advanced with
“the emergence of standards for electronic data interchange (EDI), a broadly used infrastructure
for connecting business processes such as procurement and order management in diparate
enterprises.” “During the late 1990’s, however, the birth of XML (Extensible Markup Language)
and its critical evolution from a data presentation standard to a machine-to-machine data
interchange format began to finally resolve this crucial problem.” Broad adoption of standards
such as EDI, HTML and XML resulted in the creation of “a truly interconnected ecosystem in
which organizations are integrating both technology infrastructure and business processes.”
These technology tools, effectively deployed within an industry, give birth to an ecosystem. “This
brief history of business ecosystem evolution illustrates a series of clear, relentless trends” –
industry fragmentation into interconnected industry segments sharing elements of cooperation
and competition.
What is a business ecosystem? “Like biological ecosystems, business ecosystems are formed
by large, loosely connected networks of entities. Firms interact with each other in complex ways,
and the health and performance of each firm is dependent on the health an performance of the
whole.” This analogy works on a number of levels.
1. “Firms, business units, technologies, and products all exhibit networks of
interdependencies and ecosystem-like dynamics.”
2. “The details of the interactions at one level are often crucial for shaping the interactions at
others.”
3. Managers must make significant strategic decisions in determining the interactions within
the ecosystem and the interactions with competing ecosystems. Therefore, emphasis is
placed on operational decisions made by managers.
“To the extent that the comparison of business networks to ecosystems is a valid one, it suggests
that some of the lessons from biological networks can fruitfully be applied to business networks.”
According to the authors, ecosystems should demonstrate the following:
1. We should expect to see more robustness in the face of external shocks.
2. We should expect to see a capability for creation of novelty, linked with a specialization of
network members.
3. We should expect a heterogeneous structure, with different firms adopting dramatically
different roles that influence different aspects of the stability and productivity of the
network.
The authors warn against the over application of the analogy. The assertion is not that the
business network is an ecosystem, but that “ecosystems are simply a point of departure for a
search for analogies and metaphors as well as theoretical foundations for an understanding of the
challenges and opportunities we face in formulating strategies in a networked world.” How do
business ecosystems differ from biological systems? Ecological ecosystems emphasize stability
and durability whereas business ecosystems are under enormous pressure to innovate. Unlike
ecological ecosystems, business ecosystems are in a fierce competition for members. Finally,
the intelligent actors in a business ecosystem are “capable of some degree of forethought and
planning.”
Business ecosystems challenge the traditional notion of industry boundaries. “Ecosystems may
be defined by the sharing of tools and technological components or by buyer/supplier
interactions. Ecosystems may span several traditional industries.” Therefore, “it is better to
gauge the degree of interaction between firms and to depict ecosystems as communities of firms
characterized by a given level and type of interaction (e.g., market relationships, technology-
sharing and licensing agreements).”
Chapter Three – Collective Behaviors
Why did Yahoo! “hit the wall in December 2000?” Cisco, one month later, “wrote off close to two
billion dollars in inventory.” What happened? “Yahoo! and Cisco failed because their vast
business ecosystems slowly became increasingly unhealthy and finally collapsed.” These firms
thrived as long as “their business partners could attract cash.” During periods of prosperity,
Yahoo! and Cisco “optimized their immediate profit but hurt their long-term prospects by creating
dependencies on unhealthy business communities.” When these correlated firms began to
experience financial difficulties resulting in a “shock that reverberated through the entire network.”
How can you measure the health of an ecosystem and what implications does this have for the
firm’s strategy?
“In a networked environment, no firm’s actions can be viewed in isolation.” One must take into
consideration the “dynamic interactions of the ecosystem as a whole.” To simplify the evaluation,
it is helpful to subdivide the ecosystem “into a number of related business domains.” “For the
ecosystem to function well, each domain that is critical in the delivery of a product or service
should be healthy.” Dominator firms like Yahoo! and Cisco “struck aggressive deals with their dot-
com partners in the boom years” weakening their partners financially and setting “the stage for
the collapse to come.”
What is business ecosystem health? The authors intend to identify the indicators that the system
“as a whole is durable creating opportunities for each of its domains.” These indicators include
productivity, robustness, and niche creation. Productivity, in biological ecosystems, is a
measurement of how effectively the system converts raw materials into living organisms. From a
business perspective, productivity is a measurement of how effectively technologies are being
transformed into products and services. How effectively is the ecosystem “converting innovation
into lowered costs and new products and functions?” Factor Productivity measures how
effectively the system “converts factors of productivity into useful work.” This is often measured
in terms of ROIC. A second productivity measure is “Change in Productivity over Time.” Is
productivity increasing or decreasing? A third measure is “Delivery of Innovations.” Is the
ecosystem effectively sharing innovation? Are innovations filtered through the system in a
manner that improves offerings and lowers costs? In addition to productivity, ecosystem health is
measured in terms of Robustness. Is the system able to “persist in the face of environmental
change?” Five measures of robustness are noted by the authors – Firms Survival Rates,
Persistence of Ecosystem Structure (structure unaffected by external shocks), Predictability (core
technology sustains in the face of change), Limited Obsolescence (core technology remains
useful), and Continuity of Use Experience and Use Cases (changes in the technology and its
uses does not radically impact user experience). A final indicator of ecosystem health is Niche
Creation. Does the system “exhibit variety and diversity” in support of many different firms,
technologies and offerings? Is the system exhibiting diversity and variety that drives value that is
to say are “the new categories of business meaningfully new [providing] new functionality,
[enabling] new scenarios, or [exposing] new technology or ideas?” “Does the variety of firms and
their products map to a variety of customer experiences and to convenience and effectiveness in
achieving those experiences or building downstream products?”
Ecosystem savvy firms must quickly learn what Cisco and Yahoo! have now learned. Ecosystem
health must be constantly monitored and hub firms must move “away from internal practices that
might decrease the health of ecosystem communities. The critical effects that a hub firm can
have on the collective health of networks of which it is a part cannot be ignored.”
Section Two – Ecosystem Strategies
Chapter Four – Operating Strategies
Both Enron and eBay found themselves at the center of “a massive business network of trading
partners.” One hoarded wealth while the other shared wealth with ecosystem partners. “Why did
the company that shared the wealth end up making so much more money?” These examples