Are You a Platform Leader?

Modularity and industry evolution
At the birth of many industries, a few firms develop all or almost all the components necessary to make the products. As industries evolve, what generally happens is that specialized firms emerge to develop certain components of the larger puzzle. An increasing number of industries today consist of different firms that each develop one component of a big jigsaw puzzle. Economists refer to these industries as "de-integrated." This evolution has happened in the computer industry, where companies like vertically integrated IBM and Digital Equipment Corporation (DEC) have left center stage for a specialist, hardware component maker, Intel, and a specialist, software component maker, Microsoft—and the plethora of complementary developers around them.

The reasons industries evolve this way are widely discussed, but a central tenet of many theories is the concept of modularity. A module is a unit whose structural elements are powerfully connected to each other and relatively weakly connected to elements in other units. Clearly there are degrees of connection, thus there are gradations of modularity. Many industries of complex products have evolved toward a more modular architecture, including the computer, telecom, and automotive industries. Consequences of modular designs reach far beyond the purely technical characteristics of the products, for example, the physical shape of the product or its internal structure. 4 Design decisions affect the organization of production, and modular designs provide the means for people to divide up the work in tasks or groups of tasks that are relatively independent of each other. Modularity in product design has a powerful impact on innovation: Innovation can happen on modules of the product without having to impact (and thus threaten the integrity of) the overall system.

In addition to modular designs, the vast improvement in tools of communication is another factor accelerating the pace of innovation. The development of the Internet, for example, has reduced tremendously the difficulties of coordinating work on discrete modules or components across distant locations and fostered collaboration on new products.

Another aspect of modern industry is the ubiquity of software. Organizations and individuals have used software tools in a pervasive manner to achieve improvements on products and processes. Software expertise—fueled by developments in computer higher education and the ubiquity of cheap PCs—has also reached unprecedented levels and availability. The combination of these factors leads to the fact that technological innovation—once restricted to the labs of rich and powerful companies—has never been so prevalent and widely distributed. Barriers to innovation are at a historical low.

The ability for an increased number of actors to innovate separately on different modules of systems is radically altering the nature and stability of relationships between the firms that make core products and the developers of complementary products. This book analyzes the strategies that executives at Intel, Microsoft, Cisco, Palm, NTT DoCoMo, and supporters of the Linux operating system, have developed for facing these challenges. Their strategies differ in many respects, but they also share many similarities. Each group, in their own way, follows an approach that we have called platform leadership.

Platform leadership
Platform leadership refers to the common objective sought by the companies we talked to: to drive innovation in their industry. The increased breadth of innovation described earlier creates the necessity for either one firm or a group of firms to ensure over time the integrity of an evolving platform. It also creates strategic opportunities to channel the direction of innovation on complementary modules or products. Ensuring the integrity of the platform and driving its evolution become strategic imperatives in industries where distributed innovation constantly challenges established relationships of power between suppliers of complementary products.

More and more firms want their products to become the foundation on which other companies build their products or offer their services; that is, they want to become platform leaders. A platform leader can benefit from—but is also highly dependent on—innovations developed at other firms. Platform leaders might rest easier if they had the resources to create the core components and all possible complementary products themselves for every market around the world. But this is impossible. No single company can replicate all the innovative capabilities of a market, especially at a time when tools and knowledge necessary to innovate are more widespread than ever. As a result, nearly all the platform leaders we observed have had to work closely with other firms to create initial applications and then new generations of complementary products. Platform leaders and complementary innovators have great incentives to cooperate, however, because their combined efforts can increase the potential size of the pie for everyone.

From the perspective of the platform leader, complements are both a curse and a blessing. They can be a curse when a firm that depends on complements developed externally fails to get them created in a timely manner or at a high enough level of quality or volume. On the other hand, complements can draw new customers in, inducing them to buy the core product. For Microsoft, whose core product is the Windows operating system, a large number and variety of complementary Windows-compatible software applications are a blessing because it encourages potential customers to buy Windows-based computers. Likewise, having a large number and variety of movies on VHS-compatible videocassettes available in video stores pushed the sales of VHS recorders. The availability of a large number of complementary products adds value to the core product. Innovation on complementary products, therefore, constitutes a great opportunity.

In short, in industries that center around platform products, the value of a platform increases when there are more complements. The more people who use these complements, the more incentives there are for complementary producers to introduce more complementary products, which then stimulate more people to buy or use the core product, stimulating more innovation, and so on. It is, therefore, in the interest of a platform leader to stimulate and channel innovation on complementary products.

The game is risky, though, because platform producers may fail to get other firms to cooperate and innovate, and this failure can lead to greatly reduced sales for everyone tied to the same platform. Since platforms are made of components that interact following standard interfaces, standard wars are necessarily part of platform strategies. Examples include Sony and the Betamax standard, which failed to dominate the VCR market, and the Apple Macintosh line of PCs, which has found some resurgence in recent years but has not unseated Windows machines as the mass-market standard. DEC's Alpha microprocessor failed to garner much of a following, mainly because of a lack of software applications. Informix has found a niche in the corporate database software market, but lost out to Oracle and Microsoft as the industry standard. QUALCOMM is in the midst of a global struggle with companies such as Nokia, Ericsson, AT&T, and Motorola to establish its technology as the international standard for next-generation wireless cell phones.

The Navigator browser, which fit into a platform and once had a market share of around 90 percent, declined sharply in popularity as a result of Netscape's inability to keep it as the industry standard. 5 Microsoft's Pocket PC operating system may suffer a similar fate at the hands of Palm or other competitors if Microsoft cannot persuade more companies to adopt their system for their handheld computers and personal digital assistants (PDAs), cellular telephones, or cable TV set-top boxes.

In other words, it is quite possible to fail to become a platform leader and to mismanage the process of stimulating and channeling complementary innovation. The result is an inability to exploit the dynamics of markets driven by the economic forces we have described. Of course, there are no guarantees of success in high-tech markets, where change can be quick and brutal. The VHS platform for the VCR and what has been called the "Windows-Intel" platform for the PC are now standards, but their originators did not win their markets easily or by accidents. 6 Managers and engineers at Intel, Microsoft, Cisco, Palm, and other successful platform leaders, as well as platform leader "wannabes" must work hard to establish, maintain, and grow their dominant positions.

Framework: four levers of platform leadership
Based on the companies we studied, we developed a framework that managers can use to design a strategy for platform leadership or make their existing strategy more effective. This framework—which we call the Four Levers of Platform Leadership—allows platform leaders or wannabes to design and test the validity of their strategy, given the circumstances of their industry and the competences of their corporation. Here is an outline of the four levers:

1. Scope of the firm: This lever deals with what the firm does inside and what it encourages others to do outside. Is it better for firms to develop an extensive in-house capability to create their own complements or to let the market produce complements? Is there a "happy medium" between these two extremes? If so, when is that the best approach?
2. Product technology (architecture, interfaces, intellectual property): This lever deals with decisions that platform leaders and wannabes need to make with regard to the architecture of their product and the broader platform, if the two are not the same. In particular, they need to make decisions about the degree of modularity, the degree of openness of the interfaces to the platform, and how much information about the platform and its interfaces to disclose to outside firms—potential complementors who may also become competitors. 7
3. Relationships with external complementors: This lever centers on determining how collaborative versus competitive should the relationship be between the platform leader or wannabe and the complementors. Platform leaders and wannabes also need to worry about how to achieve consensus with their partners, and how to deal with potential conflicts of interest, such as when the platform leader decides to enter complementary markets directly and turns former partners into competitors.
4. Internal organization: This lever allows platform leaders and wannabes to use their internal organizational structure to manage external and internal conflicts of interest more effectively. Options include keeping groups with similar goals under one executive, or separating groups into distinct departments in order to address potentially conflicting goals with outside constituencies. The issue of culture and process comes in here: We found that since innovative, modular industries are often ambiguous environments, where a complementor today can become a competitor tomorrow, an internal atmosphere that encourages debate (or at least tolerates ambiguity) accelerates the strategy reformulations that are sometimes necessary. At the same time, efficient internal communication of corporate strategy, once a decision has been made at the top, facilitates the implementation of strategic reorientations.

We believe that each of these levers is critical for achieving or sustaining platform leadership. The Four Levers cover both strategy formulation and implementation issues, which are intertwined. The levers are distinct but closely related; therefore, platform leaders or wannabes need to make choices on these dimensions in a coherent fashion.

The decision of what complements to make inside and what to leave to external firms is probably the single most important issue that platform leaders and wannabes have to decide—and keep deciding. It is not a onetime event because firms innovate continuously on their products and add new functionalities that may well have been performed previously by external firms. This decision encompasses choosing appropriate levels of investment in venture capital activities or acquisitions aimed at evolving the platform or helping the complements business.

Decisions on the architecture or design of the product and on how to treat intellectual property (i.e., whether to keep product interface specifications "open" or closed"), tend to have a major impact on the incentives and ability of external firms to innovate on complements. And deciding how to treat external firms is, of course, related to the scope of the firm because it requires a decision on whether to compete or to collaborate.

We shall also see that platform leaders and wannabes need to be mindful of the consequences of encroaching on the territory of developers of complements. There is a strategic trade-off between systematically entering any complementary market that seems to hold the promise of profit and maintaining goodwill and collaborative relationships with developers of complements. While some companies invest a lot of effort in building a strong reputation for not encroaching on complementors' turf, others are less careful where they trample. We shall explain the external circumstances that can justify these different behaviors and clarify the risks involved with these two approaches.

We shall also see that platform leaders or wannabes need to establish an internal organization that supports their objectives. In particular, when the objective is to maintain collaborative relationships with complementors, certain organizational design decisions—such as whether to keep particular groups under one executive or to separate groups into distinct departments—impact the ability of a platform leader to convince third parties that it will not recklessly infringe on their turf. Distinct departments reduce the fears that third parties might have to invest in complementary products and new technologies.

The important point here is that platform leaders usually need to perform a delicate balancing act between competing and collaborating with complements producers, whose products are necessary to create demand for the platform. The firms we studied relied on various means to influence outside firms, ranging from specific technical choices and organizational decisions to initiatives to enhance their external relationships and reputations.

Excerpted with permission from Platform Leadership: How Intel, Microsoft, and Cisco Drive Industry Innovation, Harvard Business School Press, 2002.

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Annabelle Gawer is an assistant professor of Strategy and Management at INSEAD where she teaches both in the Executive Education Programs and the core Strategic Management course in the MBA program.