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Value Chain Migration Death March

We’re going to start with what I call the value chain migration death march. I’m referring to the universal tendency across every company, anywhere in the world, to want to respond to their envy. In every single sector in the world, there’s a value chain. On the one side, usually the left-hand side, there are suppliers, and on the other side, usually the right-hand side, there are customers. Typically, the closer you get to customers, your margins increase. The further you get from customers, your margins usually decrease—but there are definitely exceptions to the rule.

For example, tech companies that operate platforms tend to operate on the left-hand side of the value chain, and whatever is hosted on their platforms is what interacts with customers. For a bank that hosts a capability—whether it’s some part of their digital infrastructure on a cloud server somewhere, maybe hosted by Amazon—that digital application is what interacts with customers, not Amazon. Amazon is hosting the part that interacts with customers—and they do an excellent job.

If you’re a cloud-based streaming company that hosts the capabilities of companies, the thinking is that if the cloud company has such a good understanding of what customers are doing, how they're purchasing things, how customers interacting when… Click To Tweet

Moving down the value chain is extremely difficult. The video game industry is a good example and has been in the news recently. This is a big, multibillion-dollar business. The technology companies want to get into this. They don’t want to just host the gaming system on which the game sits—they want to have the game and build billion-dollar franchises that tie in users and intellectual property around character driven merchandise, TV and movies. If you’re a cloud-based streaming company that hosts the capabilities of companies, the thinking is that if the cloud company has such a good understanding of what customers are doing, how they’re purchasing things, how customers interacting when they’re using the streaming service, and the company has the platform, they don’t want to continue to be just a “dumb” infrastructure. They want to move down the value chain, and they want to lock in access to customers by offering the service that is hosted on the infrastructure.

The telcos went through this. They laid the infrastructure on which the internet was built, but the companies that made a fortune were not the telcos—it was the companies that piggybacked off the telcos’ internet infrastructure. And the telcos’… Click To Tweet

A lot of the thinking from this comes from the lessons of the telcos in the 1990s and early 2000s. The telcos went through this. They laid the infrastructure on which the internet was built, but the companies that made a fortune were not the telcos—it was the companies that piggybacked off the telcos’ internet infrastructure. And the telcos’ share prices and market capitalizations are nowhere near that of Facebook, Microsoft, Amazon and Netflix.

There’s a bit of a tradeoff here. As you become a service that’s almost like a utility—you’re available everywhere, and you’re the only one providing the service—you have no choice but to open your platform to everyone, because you are seen as a utility. If there’s a lot of competition for the service you offer, you can say, “There’s so much competition for what we’re offering, we’re only going to make our platform available to a few people because if we decline some people, they can go to another competitor.” In many ways, Facebook is like a utility. It’s everywhere. When you reach that level, you have to open the platform to everyone, or the Department of Justice gets involved—rightly or wrongly. We’re not going to debate the merits of who’s right or wrong here, but if you open your platform to everyone, you open your platform to companies that could build an app on your infrastructure, which could suck up the majority of the value of the system. So, even though you created the platform on which they exist, you don’t get the majority of the money.

In the simplest example of this, think of companies that own land on which a telco builds a 5G network tower. Then Apple comes along and sells their phone using the 5G network. So, Apple makes a lot of money, but Apple doesn’t make as much as they could because they opened their operating system to many people to put in their apps. An app comes along, like Facebook, which makes a ton of money.

There are different ways of looking at what is the infrastructure—it could be land, the telco, the phone, the operating system on the phone, the app store on the operating system of the phone. But everyone's trying to move closer to the customer,… Click To Tweet

The point is that there are different ways of looking at what is the infrastructure—it could be land, the telco, the phone, the operating system on the phone, the app store on the operating system of the phone. But everyone’s trying to move closer to the customer, and the lesson here is that most companies fail. How many tech companies have migrated downstream to produce a hit video game? And there’s a reason for that because what makes someone successful at video games is not what makes them successful at running their core business, which I talked about in the previous Monday Morning 8 a.m.

Many years ago, I served a very large and significant oil and gas company, one of the largest in the world. They had the idea that because they had this considerable mainframe asset and they were sitting on all this data and analytics, they should create a services function like a consulting firm. They actually asked me to lead it at one point, but I declined because I thought it would never work. It’s not that a services division couldn’t exist within this oil and gas company. It could, but the services division this oil and gas company wanted to create couldn’t exist because the way they saw it, they were spending a fortune on oil services businesses, and if they developed the capability in-house, they could save the money spent on companies providing the service to them, and also create a profit center and serve other competitors with this capability. They saw it as a very viable business case. The reality is that it did not work because the oil company was run top-down and extremely risk-averse, with decades of data supporting each decision. So, when they started doing these consulting services, for lack of a better word, and they tried to bring in that kind of thinking into the services function, it never worked.

On the one hand, they had engineers who were very smart guys, and they brought in a lot of consultants, but engineers wanted certainty in the answers. If you’ve ever done a study in strategy or operations, you know that we don’t have a lot of certainty. We don’t know with certainty that if you go down this path in your corporate strategy, it’s going to work out because we don’t know what the market is going to look like. There’s no amount of data, there’s no amount of research, there is nothing which will give you that certainty. The services function never took off. It never became a significant revenue generator.

While you may control a platform, it doesn’t mean you can do everything on a platform—and it doesn't mean you should do everything on a platform. If you want to operate in different parts of the platform, you probably have to set up a ring-fenced… Click To Tweet

The main insight is that while you may control a platform, it doesn’t mean you can do everything on a platform—and it doesn’t mean you should do everything on a platform. If you want to operate in different parts of the platform, you probably have to set up a ring-fenced entity that will operate according to the rules of that new area you want to compete in rather than leveraging what made your core business great. What made your core business great is valuable in your core business, but it may not be as valuable in the new part of the platform you want to play in as you get closer to customers—which is why so many companies when they want to change their corporate strategies are ultimately forced to set up a ring-fenced entity.

What made your core business great is valuable in your core business, but it may not be as valuable in the new part of the platform you want to play in as you get closer to customers—which is why so many companies when they want to change their… Click To Tweet

So, value chain migration is very difficult to do. Very few companies have achieved it. Typically, when the company wants to do it right, they move the whole company down the value chain as opposed to keeping the core of the business in one part of the value chain and setting up other successful businesses in other parts of the value chain.

This is an excerpt from Monday Morning 8 a.m. newsletter, issue #15. 

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