2001 11 Skate To Where The Money Will Be

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Skate to Where the Money Will Be

by Clayton M. Christensen, Michael Raynor, and Matthew Verlinden

Reprint r0110d
ILLUSTRATION: BILL HALL

72 Copyright 2001 by Harvard Business School Publishing Corporation. All rights reserved.
As hockey great Wayne Gretzky used to say,
the key to winning is getting rst to where the puck
is going next. The same could be said
about succeeding in business, and a new theory
of protability could help you do just that.

Skate
to Where the
Money
Will Be
by Clayton M. Christensen,
Michael Raynor,
and Matthew Verlinden

november 2001 73
S kat e t o W h e re t h e M o n ey Wi l l B e

When IBM decided to outsource


its operating system and processor chips
in the early 1980s, it was, or appeared
to be, at the top of its source and what to hold on to as its industry begins to
game. It owned 70% of the break into pieces? How can new entrants gure out where
entire mainframe market, controlled 95% of its prots, to target their efforts to maximize protability?
and had long dominated the industry. Yet disaster fa- The pattern we observed arises out of a key tenet of the
mously ensued, as Intel and Microsoft subsequently cap- concept of disruptive technologies that the pace of
tured the lions share of the computer industrys prots, technological progress generated by established players
and Big Blue entered a decade of decline. inevitably outstrips customers ability to absorb it, creat-
Its easy to look back and ask, What were they think- ing opportunity for up-starts to displace incumbents. This
ing? but, in truth, IBMs decision t well with prevailing model has long been used to predict how an industry will
orthodoxies, particularly with the idea that companies change as customers needs are exceeded. (See the sidebar
should outsource all but their core competenciesthat is, The Disruptive Technologies Model.) Building on that
sell off or outsource any function that another company ground, this new theory provides a useful gauge for mea-
could do better or cheaper than it could. Indeed, at the suring not only where competition will arise under those
time, many observers hailed IBMs move as a master- circumstances but also where, in an industrys shifting
stroke of strategy, forward-looking and astute. value chain, the money will be made in the future.
Of course it turned out not to be, but what lessons The implications of our theory will surprise many read-
should we draw from IBMs spectacular mistake? Theyre ers because, if were right, the money will not be made
far from clear. Its easy to say, Dont outsource the thing where most companies are headed, as they busily out-
thats going to make lots of money next, but existing mod- source exactly the things they should be holding on to and
els of industry competitiveness offer very little help in pre- hold on to precisely the things they should unload. But
dicting where, in an industrys value chain, future prof- well get to that later
itability will be most attractive. Executives and investors all
wish they could be like Wayne Gretzky, with his uncanny
ability to sense where the puck is about to go. But many
A Tight Fit
companies discover that once they get to the place where Companies compete differently at different stages of a
the money is, theres very little of it left to go around. products evolution. In the early days, when a products
Over the past six years, weve been studying the evolu- functionality does not yet meet the needs of key cus-
tion of industry value chains, and weve seen a recurring tomers, companies compete on the basis of product per-
pattern that goes a long way toward explaining why com- formance. Later, as the underlying technology improves
panies so often make strategic errors in choosing where to and mainstream customers needs are met, companies are
focus their efforts and resources. Understanding the pat- forced to compete on the basis of convenience, cus-
tern helps answer some of the enduring questions that tomization, price, and exibility. These different bases of
IBMs leaders, and thousands of others before and since, competition call for very different organizational struc-
grappled with: Where will attractive prots be earned in tures at both the company and industry levels.
the value chain of the future? Under what circumstances When products arent yet good enough for mainstream
will integrated corporations wield powerful competitive customers, competitive pressures force engineers to focus
advantages? What changes in circumstances will shift on wringing the best possible performance out of each
competitive advantage to specialized, nonintegrated com- succeeding product generation by developing and com-
panies? What causes an industry to fragment? How can bining proprietary components in ever more efficient
a dominant, integrated player determine what to out- ways. They cant assemble off-the-shelf components using
standard interfaces because that would force them to
Clayton M. Christensen is a professor of business admin- back away from the frontier of whats technologically pos-
istration at Harvard Business School in Boston. Michael sible. When the product is not good enough, backing off
Raynor is a director with Deloitte Research, the research arm from the best you can do spells competitive trouble. To
of Deloitte Consulting and Deloitte & Touche. He is based in make the highest-performing products possible, then,
Toronto. Matthew Verlinden is a manager at international companies typically need to adopt interdependent, pro-
strategy consulting rm Integral, in Cambridge, Massachusetts. prietary product architectures.

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During the early days of the computer industry, for ex- service more quickly, with fewer concerns about the un-
ample, when mainframes were not yet powerful or fast intended consequences of reconguring their own cen-
enough to satisfy mainstream customers needs, an inde- tral-office facilities. Regulatory mandates cannot decou-
pendent contract manufacturer assembling machines ple an industry at an interdependent interface. As long
from suppliers components could not have survived be- as DSL service is not good enough to satisfy most users,
cause the way the machines were designed depended on the integrated telephone companies will be able to pro-
the way they were manufactured and vice versa. Nor vide better, more reliable service than nonintegrated
could an independent supplier of operating systems, core competitors.
memory, or logic circuitry have survived because these
key subsystems had to be designed interdependently, too.
When the product isnt good enough, in other words,
Going to Pieces
being an integrated company is critical to success. As the Product performance almost always improves beyond the
most integrated company during the early era of the com- needs of the general consumer, as companies stretch to
puter industry, IBM dominated its world. Ford and Gen- meet the needs of the most demanding (and most prot-
eral Motors, as the most integrated automakers, domi- able) customers. When technological progress overshoots
nated their industry during the era when cars were not what mainstream customers can make use of, companies
good enough. For the same reasons, RCA, Xerox, AT&T, that want to win the business of the overserved customers
Alcoa, Standard Oil, and U.S. Steel domi-
nated their industries at similar stages.
Their products were based on the sorts of
proprietary, interdependent value chains
The Disruptive Technologies Model
that are necessary when pushing the fron-
tier of what is possible. The disruptive technologies model contrasts the pace of techno-
When a nonintegrated company tries to logical progress with customers ability to use that progress. Ac-
compete under these circumstances, it usu- cording to the model, there are two types of performance trajec-
ally fails. Stitching together a system with tories in every market. One trajectory, depicted by the shaded
other partnercompanies is extremely dif- area, shows how much improvement in a product or service cus-
cult when the subsystems and expertise tomers can absorb over time. The other trajectory, shown by the
those companies provide are interdepen- solid lines, depicts the improvement that innovators in the in-
dent. We could offer numerous historical dustry generate as they introduce new and enhanced products.
examples, but there are plenty of illustra-
tions from industries that are still emerg-
Performance
ing. In the late 1990s, for example, many y
tor
nonintegrated companies attempted to ra jec ogy
t l
offer high-speed DSL access to the Internet ce no
m an tech
r t
over phone lines operated by telephone rfo en
Pe pres anding cust
omers Performance
of Most- dem
}
companies. Most of these attempts failed. that customers
in the main-
Many believe that low prices for DSL ser- stream market
vice that were rooted in regulatory pecu- cu st om ers can absorb
anding
Least-dem
liarities of the Telecommunications Act of ce
an
1996 are what drove the competitive local rm
e rfo
p
exchange carriers toward bankruptcy. This w ory
Disruptive Neaject
was only the proximate cause of their technology tr
demise, however. The fundamental issue is Time
that at this point in the industrys evolu-
tion, DSL technology isnt good enough Almost always, this second trajectory the pace of technological
yet, and there are, as a result, too many un- innovation outstrips the ability of customers in a given tier of
predictable interdependencies between the market to absorb it. This creates the potential for innovative
what focused DSL providers need to do companies to enter the lower tiers of the market with disruptive
and what the telephone companies must technologies cheaper, simpler, more convenient products or
do in response. The incumbent phone services. Almost always, the leading companies are so absorbed
companies capacity to span the whole with upmarket innovations addressed to their most sophisticated
value chain has been a powerful advan- and protable customers that they miss the disruptive innova-
tage. They understand their own network tions. Disruptive technologies have caused many of historys best
architectures and can consequently offer companies to plunge into crisis and fail.

november 2001 75
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in less-demanding tiers of the market are forced to consequence. The exhibit The Dis-Integration of the
change the way they compete. They must bring more ex- Computer Industry illustrates how this happened in
ible products to market faster and customize their prod- that eld. During its early decades, the dominant com-
ucts to meet the needs of customers in ever smaller mar- panies were integrated across most value-chain links
ket niches. because competitive conditions mandated integration.
To compete on these new dimensions, companies must As the personal computer disrupted the industry, how-
design modular products, in which the interfaces be- ever, it was as if the industry got pushed through a bo-
tween components and subsystems are clearly specied. logna slicer. The dominant, integrated companies were
Ultimately, these interfaces coalesce into industry stan- displaced by specialists that competed in horizontal
dards. Modular architectures help companies introduce strata within the value chain.
new products faster because subsystems can be improved This shift explains why Dell Computer was so success-
without having to redesign everything. Companies can ful in the 1990s. Dell did not succeed because its products
mix and match the best components from the best sup- were better than those of competitors IBM, Compaq,
pliers to respond to the specic needs of individual cus- and the like. Rather, overshooting triggered a shift in
tomers. Although standard interfaces invariably force the basis of competition to speed, convenience, and
compromises in system performance, competitors aim- customization, and Dells business model was a perfect
ing at overserved customers can comfortably trade off match for that environment. Customers were delighted
some performance to achieve the benets of speed and to buy computers with outsourced subsystems, custom-
exibility. assembled to their own specications and delivered in-
Once a modular architecture and the requisite indus- credibly quickly at competitive prices. This also explains
try standards have been dened, integration is no longer how Cisco, with its disruptive router and its noninte-
crucial to a companys success. In fact, it becomes a grated business model, bested more integrated com-
competitive disadvantage in terms of speed, exibility, petitors like Lucent in the market for telecommunica-
and price, and the industry tends to dis-integrate as a tions equipment.

The Dis-Integration of the Computer Industry

Mainframes and minicomputers were never good own proprietary designs and components. The PC,
enough or fast enough or cheap enough to create a mass though, very quickly became good enough for the
market and were therefore always the province of large, average consumer, giving rise to an army of specialized
integrated players who built their machines from their players.

1960 1980 1980 1990 1990 present

Equipment Teradyne, Nikon, Canon, Applied Materials, Millipore

Materials Monsanto, Sumitomo Metal, Shipley

Components Intel, Micron, Quantum, Komag

Product design IBM, Compaq, Dell, Gateway, Packard Bell


Digital Equipment
IBM

Assembly IBM, Compaq Solectron, Celestica


Control Data

Operating system Microsoft

Application software WordPerfect, Lotus, Borland, Microsoft

Sales and distribution CompUSA Dell

Field service Independent contractors

76 harvard business review


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formulas and measures; they can only be made through


Fuzzy Links the intuition of experienced lending officers. The high-
The careful reader will have noticed that the interfaces end bankers who create innovative, complex nancial in-
between stages in the value chain are central to our ar- struments for these customers play a similar role to engi-
gument both to the forces that support integration in neers who push the technological envelope when product
the early years of an industry and to those that ultimately functionality is not good enough. In both cases, meeting
pull an industry apart into component pieces. Theyll be- the needs of the most demanding customers requires that
come even more important when we move on to prof- all the constituent parts be under one roof, able to com-
itability ows in a moment. So lets look more closely at municate through organizational rather than market
what we mean by the interfaces between components mechanisms.
and subsystems. The simpler tiers of the lending market, on the other
Say a company is considering whether its feasible to hand, are being disrupted by innovations in the way
procure a subsystem from a supplier or partner rather credit-worthiness is established specically by credit-
than make it in-house. Three conditions must be met. scoring technology and advances in asset securitization.

The bedrock principle is this: Those


who control the interdependent links
in a value chain capture the most prot.
First, managers need to know what to specify which In these tiers, lenders know and can measure precisely
attributes of the item theyre procuring are crucial and those attributes that determine the likelihood that a bor-
which are not. Second, they must be able to measure rower will repay a loan. Veriable information about
those attributes so they can verify that they have received borrowers how long they have lived, where they live,
what they need. Third, there cant be any unpredictable how long they have worked, where they work, what their
interdependencies: They need to understand how the income is, and whether theyve paid bills on time is fed
subsystem will perform with the other pieces of the sys- into powerful algorithms, which are used to automate
tem so that it can be used with predictable effect. These lending decisions. Credit scoring took root in the 1960s in
conditions speciability, veriability, and predictabil- the lowest tier of the market, as department stores began
ityare prerequisites to modular designs that enable com- to issue their own credit cards. Then, unfortunately for
panies to work efficiently with suppliers and partners. the big banks, the specialist horde of nonbank institutions
They constitute what economists would term sufficient moved inexorably upmarket in pursuit of prots rst to
information for an efficient market to emerge for a par- general consumer credit-card loans, then to automobile
ticular component or subsystem. and mortgage loans, and now to small-business loans.
Typically, when product performance has become True to form, the lending industry in these simpler tiers
more than good enough, the technologies being used are of the market has largely dis-integrated, as these special-
mature enough for these conditions to be met facilitat- ist companies have emerged, each focusing on just a slice
ing the decoupling of the value chain. It is when perfor- of added value.
mance is not good enough that new technologies are used
in new ways and in those circumstances the conditions
of speciability, veriability, and predictability often are
Where the Money Goes
not met. When sufficient information does not exist at an Clearly, companies competing in an integrated market
interface, managerial coordination will always trump face very different challenges from those competing in a
market mechanisms, reinforcing the strength of inte- fragmented market the ball game changes fundamen-
grated companies. tally once components become modular and customers
The evolving structure of the lending industry offers thoughts turn to speed or convenience rather than func-
a good example of these forces at work. Integrated banks tionality. Sources of protability change as well. Our model
such as Chase and Deutsche Bank have powerful compet- can help managers, strategists, and investors assess how
itive advantages in the most complex tiers of the lending the power to grab prots is likely to shift in the future.
market. Integration is key to their ability to knit together The bedrock principle is this: Those who control the inter-
huge, complex nancing packages for sophisticated and dependent links in a value chain capture the most prot.
demanding global customers. Decisions about whether In periods when product functionality is not yet good
and how much to lend cannot be made according to xed enough, integrated companies that design and make

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Management Education Ripe for Dis-Integration


Few industries are exempt from the forces of disruption better strategy. It may not be as comprehensive as an MBA
and dis-integration, management education included. This strategy class, but because its better targeted to the stu-
industry is changing, and whether these changes prove to dents immediate needs, it often proves more useful to
be a boon or a bane to leading schools of management de- them and to their employers. And in contrast to the lead-
pends on how they address these forces. ing schools integrated structure, on-the-job management
At the top of the heap, big-name business schools offer education is dis-integrated. Hundreds of specialized com-
top-tier MBA students a premium, expensive product. Its panies develop materials; others design courses; still oth-
worth it: Graduates easily command starting salaries of ers produce and teach them.
$130,000 or more, and theyre in high demand. True to the How should the top management schools react? They
model, the architecture of top-tier MBA programs is inter- could, of course, ignore the trend there wont be a dearth
dependent. Their premise is that future managers cant of MBA students anytime soon, and these institutions will
understand marketing, for example, unless they study likely survive in their current form for years. If they ignore
product development, and they cant study product devel- the disruption, though, they will gradually lose inuence
opment without studying manufacturing, and so on. The because the vast majority of learning about management
programs are also integrated in the sense that the faculty already occurs on the job. A second alternative is to skate
members do everything, soup to nuts: conduct research, to where the money is: to the design and assembly of cus-
writes cases and articles, design courses, and teach. tomized courses for on-the-job training. This is tempting
But the familiar pattern of overshooting and subse- because the custom executive-education market is grow-
quent modularization is becoming evident. As graduates ing, but it would be hard to compete against the focused,
of these top-tier schools have become more expensive to exible specialists already in that space.
employ, a signicant portion of graduates now take jobs A better idea is to skate to where the money will be to
with consulting rms, investment banks, and high-tech become the Intel Inside of corporate-training programs.
start-ups. The established operating companies that his- That means providing not just single components in
torically had been major employers of MBAs increas- the form of cases or articles but rather subsystems,
ingly nd these graduates to be too expensive to t into modules with proprietary internal architectures. These
their salary structures and career paths. would be predened sets of cases, articles, news clips,
Increasingly, those companies, and even some con- and video materials from which well-dened insights
sulting rms, are opting to train their own. They hire can cumulatively but interdependently be built. Teach-
people with bachelors or graduate technical degrees, ing notes that make explicit the connections within
then help them build managerial skills in formally or- these materials connections that historically have
ganized institutions like Motorola University and GEs resided only in the intuition of the professors who wrote
Crotonville. Other companies have less-structured, but the materials would make it simple for a larger set of
equally extensive, management-training programs. less well-trained instructors in a corporate setting to do a
Last year, IBM spent more than $500 million on man- great job teaching powerful concepts. Companies that de-
agement training, for example, and announced it sign courses could mix and match such materials to ad-
would begin selling management education programs dress students needs.
to other companies executives as well. Always, disruption facilitates new waves of growth in an
Like most disruptions, these on-the-job training industry because it enables more people to buy and con-
programs are probably not as good as what theyre sume. If our model is right, future prots in the growing
replacing, at least in the way the elite schools dene portions of this industry will come not from the design
good. Theyre certainly not as thorough, and their and assembly of courses, anyway, but from the develop-
students arent, on average, quite as polished and ment of the subsystems that make up those courses. Thats
prepared as the best MBA students. But like other where the steep scale economies and differentiated mate-
disruptive businesses, they compete on different rials should reside. If the leading management schools
terms. On-the-job training programs are modular, worked in this way to facilitate their own disruption, they
custom-assembled courses whose content is tailored would nd they can continue to teach MBA students
to specic issues the manager-students face. within their conventional model for the foreseeable future,
Managers will take a three-day course on even as they participate in the growth of the total manage-
strategic thinking, for instance, then ment education industry and continue to enjoy much of
use what theyve learned to dene a the prot as well.

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end-use products typically make the most money, for two cate anything you can do very quickly. And because most
reasons. First, the interdependent, proprietary architec- of the costs in an outsourcing-intensive business model
ture of their products makes differentiation straightfor- are variable rather than xed, there are minimal econo-
ward. Second, the high ratio of xed to variable costs, mies of scale, so that large and small competitors have
which is inherent to the design and manufacture of archi- similar costs. Making an undifferentiated product at un-
tecturally interdependent products, creates steep econo- differentiated costs is a recipe for earning undifferenti-
mies of scale. Larger competitors can amortize high xed ated prots.
costs over greater volume, giving them strong cost advan- So, whats our Compaq engineer to do? Shell put pres-
tages over smaller competitors. Making highly differenti- sure on her suppliers to invent faster microprocessors and
ated products with strong cost advantages is a license to higher-capacity, lower-cost disk drives.
print money, and lots of it. Overshooting at the system level often throws the sub-
Hence IBM, as the most integrated competitor in the system suppliers back to a stage where their product is
mainframe computer industry, made 95% of the indus- not good enough for what the system assembler needs.
trys prots from just a 70% market share. And from the Competitive forces consequently compel the subsystem
1950s through the 1970s, General Motors garnered 80% of suppliers to create architectures that are increasingly in-
the prots from about 55% of the U.S. auto market. Most terdependent and proprietary as they try to push the
of IBMs and GMs suppliers, by contrast, survived on sub- bleeding edge of performance. They have to do this to win
sistence prots year after year. the business of their immediate customers, who are the
But when the large integrated players overshoot what designers and manufacturers of modular products.
their mainstream customers can use, the tables begin to Hence, as a natural and inescapable result of the shift in
turn. Disruptive competitors begin to move upmarket, industry structure, the place where companies are used to
and the power to make money shifts away from compa- making a lot of money the end-user stage becomes un-
nies that design and assemble the end-use product toward likely to be the place where money will be made in the fu-
the back end of the value chain to those companies that ture. And, conversely, the places where attractive prots
supply subsystems with internal architectures that are were rarely made in the past components and subsys-
still technologically interdependent. tems often become highly protable.
A good way to visualize this is to imagine an engineer The exhibit Where the Money Went in the PC In-
employed at Compaq whose boss just told her to design dustry illustrates how this worked in the desktop com-
a desktop computer better than Dells, IBMs, or Hewlett- puter market in the 1990s. Initially, money owed from
Packards. How would she do it? When designing and as- the customer to the companies that designed and assem-
sembling a modular product, your competitors can repli- bled computers; but as the decade progressed, less and

Where the Money Went


Customers
in the PC Industry

Desktop computer
As PCs became good enough for main- designer/assemblers
stream users, prots owed from the
customers through the assemblers
(the IBMs and Compaqs of the world)
to lodge in the component makers
the operating system maker (Micro-
soft), the processor maker (Intel), and
initially to the memory chip makers
and disk drive manufacturers. But as Operating system Microprocessor DRAMs Disk drives
DRAM chips and drives became good
enough for the assemblers, the money
owed even further up the value chain
to DRAM equipment makers and head
and disk suppliers. Equipment makers Heads and disks

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less of it stopped there as prot. Quite a bit of this money off asset-intensive units that design and manufacture
owed over to operating system maker Microsoft and components to companies that see in those same opera-
lodged there. Another chunk owed to processor manu- tions the opportunity to create subsystems whose archi-
facturer Intel and stopped there. Money owed to the tectures are progressively more interdependentthus im-
DRAM chip makers such as Samsung and Micron Tech- proving the numerator of their ROA ratio. Lucents recent
nology as well, but not much of it stopped there. It owed spin-offs of its component and manufacturing operations
through them and accumulated instead at companies like is an example. This seems perfectly logical and necessary,
Applied Materials, which supplied the chip-manufacturing given the increasingly modular character of many of Lu-
equipment that the DRAM makers used. Similarly, money cents systems. But with perfect predictability, this pres-
owed right through the assemblers of disk drives such as sure from Wall Street to boost ROA forces companies to
Quantum and lodged at the stage where heads and disks skate away from the place where the money will be made
were made. in the future.
Whats different about the places where the money col- This scenario could soon play out in one of IBMs busi-
lected and those where it didnt? For most of this period, nesses. Through the 1990s, the capacity of the 2.5-inch
prots lodged with the products that were the ones not disk drives used in notebook computers tended to be in-
yet good enough for what their immediate customers adequate. True to form, their architectures were interde-
needed. The architectures of those products therefore pendent, and the design and assembly stage was very

Executives whose companies


are currently making lots of money
ought not to wonder whether
the power to earn attractive prots
will shift, but when.
tended to be interdependent and proprietary. Companies protable. As the leading manufacturer, IBM enjoyed 40%
in the blue boxes could only hang onto subsistence prof- gross margins. Now, drive capacity is becoming more than
its because the functionality of their products tended to good enough for notebook computer makers, presaging
be more than good enough, and so their architectures the decline of what has been a beautiful business.
had become modular. If IBM plays its cards right, however, it is actually in
Consider the DRAM industry. Because the architecture a very attractive position. As the most integrated drive
of their chips was modular, DRAM makers could not be maker, it can skate to where the money will be by using
satised with even the very best manufacturing equip- the advent of modularity to detach its head and disk op-
ment available. To succeed, DRAM producers needed to erations from its disk drive design-and-assembly busi-
make their products at ever higher yields and ever lower ness. If IBM begins to sell its components aggressively
costs. This rendered the functionality of the equipment to competing disk drive makers, it can continue to
that Applied Materials and other such companies made enjoy the most attractive prot levels in the industry.
not good enough. As a consequence, the architecture of There was a time IBM could ght this particular war
this equipment became interdependent and proprietary, and win. Now, a better strategy is to sell bullets to the
as the equipment makers strove to inch closer to the per- combatants.
formance their customers needed. IBM has already made similar moves in its computer
business through its decisions to chop up its integrated
value chain and aggressively sell its technology, compo-
Where Companies Go Wrong nents, and subsystems in the open market. Simultane-
Once an industry starts to fragment, a very predictable ously, it has created a consulting and systems integration
thing happens to companies that design and assemble business at the high end and de-emphasized the design
modular products. They face investor pressure to improve and assembly of computers. As IBM has skated to those
their return on assets but nd that because they cant dif- points in the value chain where complex, nonstandard
ferentiate their products or make them at a lower cost integration needed to occur, that has led to a remark-
than competitors, they cant improve the numerator of able and remarkably protable transformation of a
their ROA ratio. So they shrink the denominator; they sell huge company. To the extent that an integrated company

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like IBM can exibly couple and decouple its operations, change in the basis of competition, which has precipi-
rather than irrevocably sell off operations, it has greater tated a change in architecture, which has forced the dom-
potential than a nonintegrated company to thrive from inant, integrated rms to dis-integrate.
one cycle to the next. To become fast and exible, IBMs PC business out-
sourced its microprocessor to Intel and its operating system
Where Will the Money Be to Microsoft. But in the process, IBM hung onto where the
money had been the design and assembly of the com-
in the Auto Industry? puter system and put into business the two companies
We believe this model can help managers, strategists, and that were positioned where the money would be. GM and
investors in a wide variety of industries see into the future Ford, with the encouragement of their investment
with greater clarity than the traditional tools of historical bankers, have just done exactly the same thing. They have
data analysis have allowed. When we consider, for exam- spun out the pieces of the value chain where the money
ple, where the money in the automobile industry will go will be in order to stay where the money has been.
in the future, the car companies seem to be falling into ex- Ford and GM had no choice but to decouple their com-
actly the same trap that IBM did some 15 years ago. ponent operations from their design-and-assembly busi-
While automobiles often used to rust or fall apart me- nesses. Indeed, they gave their shareholders the option of
chanically well before their owners were ready to part owning one or both. But rather than an irreversible di-
with them, auto quality now has overshot what most cus- vestiture, they might have taken a page from IBMs re-
tomers want or need. In fact, the most reliable cars usu- cent forays into opportunistic decoupling, ignored the
ally go out of style long before they wear out. As a result, siren song of investment bankers, and found a way not to
the basis of competition is changing. Whereas it used to shed those asset- and scale-intensive businesses where
take six years to design a new car model, today it takes the numerator of the ROA ratio will likely be more at-
less than two. Car companies routinely compete by cus- tractive in the future. This will be especially true if shifts
tomizing features to the whims of smaller and smaller in customer demand mandate some sort of reintegration in
market niches. In the 1960s, it was not unusual for a the future.
model to sell a million units a year. Today, the market is Managers of the slimmed-down automakers can still do
far more fragmented: If you sell 200,000 units of a par- well, but theyll need to dramatically change the way they
ticular model, youre doing ne. Some makers now do business in the design-and-assembly stage. They need
promise that you can walk into a dealership, custom to do in their industry what Dell did in the computer in-
order a car exactly to your desired conguration, and dustry become consummately fast, exible, and conve-
have it delivered in ve days roughly the response time nient. Overshooting changes the game. If GM and Ford
that Dell Computer offers. can play this new game better than competitors, they can
To compete in this way, automakers are adopting mod- still prosper, much as Dell did in the 1990s against com-
ular architectures for their mainstream models. Rather petitors who hadnt mastered the new rules as effectively.
than knitting together individual components from di-
verse suppliers, theyre procuring subsystems from fewer The implications of these ndings are clear. The power
tier-one suppliers. The architecture within each subsys- to capture attractive prots will shift in the value chain to
tem braking, steering, chassis, and the like is becoming those activities where the immediate customer is not yet
progressively more interdependent as these suppliers satised with the functionality of available products. It is in
work to meet the auto assemblers performance and cost these stages that complex, interdependent integration oc-
demands. Inevitably, the subsystems external interfaces cursactivities that create steeper economies of scale and
are becoming more modular because the economics of greater opportunities for differentiation. The power will
using the same subsystem in several car models more shift away from activities where the immediate customer
than compensates for any compromises in performance is more than satised because it is there that standard,
that might result. modular integration occurs. In most markets, this power
As the basis of competition has shifted, the vertically in- shift occurs tier by tier in a way that is quite predictable.
tegrated automakers have had to break up their value Executives whose companies are currently making lots
chains so they can more quickly and exibly incorporate of money ought not to wonder whether the power to earn
the best components from the best suppliers. GM subse- attractive prots will shift, but when. If they watch for the
quently spun out its component operations into a sepa- signals, quite possibly they can prosper in all cycles, rather
rate company, Delphi Automotive Systems, and Ford has than in only one.
spun out its component operations as Visteon. Thus, the
same thing is happening to the auto industry that hap- Reprint r0110d
pened to computers: Overshooting has precipitated a To place an order, call 1-800-988-0886.

november 2001 81

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