Here is a brief excerpt from a classic article (1999) written by John Hagel III and Marc Singer for the McKinsey Quarterly, published by McKinsey & Company. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.
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The forces that fractured the computer industry are bearing down on all industries. In the face of these changes, companies must ask themselves: What business are we in?
In the late 1970s the computer industry was dominated by huge, vertically integrated companies such as IBM, Burroughs, and Digital Equipment. With their vast advantages of scale and huge installed base of users, these companies seemed to be unassailable. Yet just ten years later, power in the industry had shifted: the behemoths were struggling to survive while an army of smaller, highly specialized companies was thriving. What happened?
The industry’s transformation can be traced back to 1978, when a then-tiny company, Apple Computer, launched the Apple II personal computer. The Apple II’s open architecture unlocked the computer business, creating opportunities for many new companies that specialized in producing specific hardware and software components. Immediately, the advantages of the generalist—size, reputation, integration—began to wither. The new advantages—creativity, speed, flexibility—belonged to the specialist.
The story of the computer industry illustrates the crucial role that interaction costs play in shaping industries and companies. These costs represent the money and time expended whenever people and companies exchange goods, services, or ideas.1 The exchanges can occur within a company, among companies, or between a company and a customer, and they can take many everyday forms, including management meetings, conferences, phone conversations, sales calls, reports, and memos. In a real sense, interaction costs are the friction in the economy. Taken together, they determine the way companies organize themselves and form relationships with other parties. All else being equal, a company will organize in whatever way minimizes overall interaction costs.
Apple’s open architecture sharply reduced interaction costs in the computer industry. By conforming to a set of well-documented standards, specialized companies could, for the first time, work together easily to produce complementary products and services. As a result, tightly coordinated webs of companies—such as Adobe Systems, Apple, Intel, Microsoft, Novell, and Sun Microsystems—could form and ultimately compete effectively against the entrenched, vertically integrated giants. Many of the new companies grew very large very quickly, but they never lost their focus on specialized activities.
The moral of the story is that changes in interaction costs can cause entire industries to reorganize rapidly and dramatically. Today, that fact should give all managers pause, for the world economy is on the verge of a broad, systemic reduction in interaction costs. Electronic networks, combined with powerful PCs, are permitting companies to communicate and exchange data far more quickly and cheaply than ever before. As business interactions move on to electronic networks such as the Internet, basic assumptions about corporate organization will be overturned. Activities that companies have always believed to be central to their businesses will suddenly be offered by new, specialized competitors that can do those activities better, faster, and more efficiently. Executives will be forced to ask the most basic and discomfiting question about their companies: what business are we really in? The answers will determine their fate in an increasingly frictionless economy.
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Here is a direct link to the complete article.
John Hagel is an alumnus of McKinsey’s Silicon Valley office, and Marc Singer is a principal in the San Francisco office. They are the authors of Net Worth: Shaping Markets When Customers Make the Rules (Harvard Business School Press, 1999), from which this article is adapted. This article originally appeared in Harvard Business Review, March–April 1999, and received Harvard Business Review’s 1999 McKinsey Award for best article. Copyright © 1999 President and Fellows of Harvard College. Reprinted by permission. All rights reserved.