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Published

1

Apr

2015

Report

Leveraging ‘The Matrix’ – Digital Ecosystem Dynamics and Strategies

The meaning of ‘the Matrix’

Like roads, telephones and electricity in the 20th century, an ever-more capable digital ecosystem is becoming the underlying business infrastructure of our time. Whereas in the past each major industry sector had its own vertical ‘stack’ of processes and systems, firms must now leverage powerful ‘horizontal’ capabilities that are used across many industries. These new capabilities are radically transforming many aspects of business and society, and will only get stronger over time.

Leveraging ‘The Matrix’ – Digital Ecosystem Dynamics and Strategies

Figure 1 – Leveraging ‘the Matrix’ – key report messages

Figure 1 – Leveraging ‘the Matrix’ – key report messages

In this report, we refer to this emerging set of services as ‘the Matrix’. While we could have easily used existing terms such as the internet, the web or the cloud, we believe that the metaphor of a matrix best captures the growing friction and synergies between vertical and horizontal market forces, as illustrated above. It also calls to mind the famous 1999 movie. While ‘the cloud’ suggests something ‘out there’, like it or not, we are all part of the Matrix – a place where our virtual identities increasingly have a life of their own.

Of course, the creators of the movie imagined a deeply dystopian future, where humans are used merely to provide energy to the machines that are really in charge. But despite the recent warnings from no less than Stephen Hawking, Bill Gates, Steve Wozniak and Elon Musk regarding the rise of machine intelligence and the risk of human obsolescence, we are not worried about these darker possibilities – at least, not within this report’s five- to ten-year timeframe.

In this report, we will explain how the Matrix is now challenging huge swathes of the global economy. We will put particular emphasis on the need for firms and their management to understand and leverage these capabilities, and even to influence and contribute to them. Incumbent firms will discover many opportunities if they can embrace these changes and develop effective digital ecosystem strategies. But as the history of roads, telephones and electricity suggests, major shifts in societal infrastructure often result in new industry leaders. Not every firm will make the transition to the Matrix-based future.

Figure 2 – The Matrix is the economic infrastructure of our time

Figure 2 – The Matrix is the economic infrastructure of our time

We have chosen the metaphor of the Matrix because it captures today’s increasingly pervasive digital world as well as the growing competition between the vertical (grey) columns and horizontal (green and gold) rows shown in the figure. In the past, most industries relied upon their own functional and process ‘stacks’. For example, major banks would have their own branches, data centres, credit cards, ATMs, CRM systems, loan approval processes, investment advisors and so on.

But increasingly the most interesting new businesses come from firms leveraging the green layers. Consider the way that Uber has taken advantage of public infrastructure – smart phones, cloud computing, global positioning services, mapping software and internet payment mechanisms. While Uber has initially focused on the market for taxis, it’s easy to see how it could eventually be woven much more deeply into the overall economic fabric in areas such as home deliveries, car sharing/rentals, mass transit systems, and a wide range of social media and location-based applications.

Clients must understand that these and other public, horizontal infrastructure capabilities will continue to emerge, even though you didn’t ask for them. They are not there waiting patiently to be ‘sourced’ as alternatives to in-house provision. They are primarily there as components – usually designed for some other purpose – that enable your firm to develop new products, services and business models. They are the building blocks of the future, and they cost you nothing until they are used.

One thing is for sure. The capabilities in each of the layers above will continue to rapidly improve – more bandwidth, improved security and resilience, new payment methods, more systematic crowd-sourcing, more reliable digital reputations, and so on. No layer is even close to mature.

But the biggest future impacts will likely come from the new layers being built on top of today’s capabilities. As suggested by the figure, these include smart sensors, the internet of things (IoT) and machine-to-machine (M2M) communications, often combined with algorithms, artificial intelligence, and vast knowledge bases such as Google and Watson. It is this layer of awareness and intelligence that will make the Matrix metaphor even more apt, while likely triggering another wave of major disruptions.

Figure 3 – Matrix businesses play by different rules

Figure 3 – Matrix businesses play by different rules

The reason that Matrix firms are so often disruptive is that they clearly play by very different rules, and this makes them hard to compete with. They have learned that being ‘asset light’

is often a great and sustainable advantage. Uber owns no vehicles; Airbnb no hotel rooms; Alibaba no inventory; Google, Facebook and Twitter no content; Nest no energy; Kickstarter no branches; and so on. Yet clearly, these virtual firms can be extremely successful and profitable.

In addition, Matrix firms deeply understand the virtues of cloud computing. Their costs are mostly variable and thus can be ramped up or down as needed. They are built to scale in a graceful manner and to generate massive cash flows as soon as demand growth kicks in. They use the latest (often open source) technologies, so continuous innovation, development, deployment and real-time data management are the norm. Similarly, the use of internet, web and other standards enables agile, loosely coupled business models.

But perhaps the biggest differences are financial. Many internet markets are pretty much winner take all, with most of the spoils going to a single market leader. Additionally, many Matrix firms have the luxury of taking a profits later approach. For example, over its more than 20-year history, Amazon has generated cumulative profits of about $3 billion, but at the time of writing its market capitalization was roughly $170 billion. This doesn’t mean that Amazon is over-valued; merely that there are different rules for different firms. Matrix firms can use their high valuations to acquire innovative new firms at prices that incumbents can rarely afford.

When all of these advantages are combined, the best of the new firms are able to be customer intimate (through localization and personalization), operationally excellent (through scale, low fixed costs and real-time optimization) and product leaders (through unique capabilities and strategic acquisitions) all at the same time – something that has generally been impossible for traditional firms. The best are successfully challenging more than 20 years of value discipline thinking.

And as shown on the following page, these changes and advantages are just getting started.

Figure 4 – The Matrix will only get smarter and more self-aware

Figure 4 – The Matrix will only get smarter and more self-aware

"The Matrix is only just beginning to hit its stride, and a new generation of powerful higher-order capabilities is now emerging. The figure shows a few examples."

"The advent of low-cost digital sensors, connected 24/7 to the internet, will make it possible and economically feasible to track virtually anything in real time. Companies will be able to manage their equipment at client sites. Doctors will be able to monitor their patients as they walk around. Facial recognition software will be able to recognize us in almost any context.

Watson-level computer power will make it possible to tackle most optimization and resource allocation problems in near real time. Smart end-to-end systems will be the norm, generating all manner of new data and insights."

"But the most disruptive gains will come from the ability to call on these vast information resources as low-cost consumable utilities. Imagine the robot (or car) of the future that has access to everything that Google knows in near real time: it knows exactly where it is and what is in the surrounding area; it has access to any sort of repair, emergency or communication service that might be necessary; it can recognize faces and find out about the people nearby; it can shift between languages at will – all at very low cost. The potential for major new forms of innovation and competitive advantage is clear."

"In this hyper-connected world, the volume of 24/7 machine-to-machine communications will dwarf the level of human interaction. In theory, this could put unbearable pressure on network bandwidth. But network technology will evolve so that machines can talk directly to one another using low-power Bluetooth and/or mesh technologies. The cars of the future, whether self-driving or not, will need to talk directly to nearby cars in real time, without human
intervention or full internet reliance. The Matrix will truly enable The Second Machine Age1 ."

Figure 5 – Value chains are becoming end-to-end, with shifting profitability

Figure 5 – Value chains are becoming end-to-end, with shifting profitability

"Businesses have been becoming more specialized for decades, arguably a century. In the early days of the automobile industry, the Ford Motor Company didn’t just have factories for making cars. It owned steel companies, shipping firms and even rubber plantations. No-one does this anymore, and the global automobile industry now consists of hundreds of thousands of specialized firms. The computer industry – once dominated by the vertically integrated IBM – has followed a similar path."

"While industries such as banking, insurance, hospitals, pharmaceuticals and utilities have experienced less dramatic change, they too are becoming more focused. Our research shows that roughly two-thirds of large firms believe they are becoming more specialized over time, and only about 5 percent less specialized."

"On the other hand, the leading Matrix firms themselves continue to diversify. Apple has moved into TV, watches and cars; Google into robots, cars and retail delivery; Facebook into news, money transfers and even drone-based WiFi; Amazon and Jeff Bezos into just about everything. Perhaps the best way to view today’s incumbent specialization is through the lens of their shrinking horizons as the Matrix expands ever more ambitiously into the future."

"The Matrix is affecting business value chain evolution in two other important ways. First, value chains are being lengthened – from the customer experience at one end to Big Data analytics at the other, with all manner of specialized services in between. In most sectors today, the customer is actively part of the value chain – posting reviews, advice and suggestions, personalizing technologies, continually learning. This is why we put so much emphasis on the importance of customer co-creation.2"

"Less obvious is the fact that in a Matrix environment profit migration is the norm. Profits migrate to where there is either unique value or a dominant market position – think Intel and Microsoft in the personal computer market. Today, this means (for example) that Apple makes most of the money in the mobile phone and online music markets, as Uber does and will in taxi services.The potential for major profit migrations in cars, healthcare, financial services and other areas will be discussed throughout this report."

Figure 6 – The Matrix is unbundling many traditional business models

Figure 6 – The Matrix is unbundling many traditional business models

Large firms often have a number of different business units. While some units may be more profitable than others, most traditional firms have generally positioned themselves as full service providers. For example, in banking the strategy was to have products for a wide range of financial needs and ‘cross-sell’ the customer into additional products.

But as we have seen, the Matrix is driving structural business change. As more and more Matrix firms emerge, the incumbents’ control over the marketplace, and their share of total value-added, is bound to shrink. Matrix firms typically target the most profitable elements of the business, forcing incumbents to compete on individual services and to unbundle their business models. Today, virtually every part of the value chain is in play, as shown in the industry examples in the figure.

Of all the shifts under way the most important questions revolve around shaping the customer experience: Who will have the consumer’s digital trust? Who will have access to customer data? Who will create the strongest customer lock-in? Who will be best positioned to provide additional services and extract future profits?

Again, let’s consider banking. Banks have traditionally controlled the major payment technologies – such as electronic funds transfer, MICR encoding, magnetic stripe cards and ATMs. But increasingly it appears that payment technology will become part of the Matrix – be it from Apple, Facebook, PayPal (and Venmo), Google, Bitcoin or some other digital wallet technology. Similarly, as mobile phones and the internet of things (wearables, blood pressure/ testing and so on) become important parts of the healthcare value chain, Matrix firms are seeking to carve out a prominent place within the medical ecosystem.

While the business press tends to focus on whether particular industries will be disrupted or not, things are not so binary. It is very unlikely that Matrix players will take over the entire healthcare industry, but they might well capture significant chunks of the customer experience and other value chain components. The vertical columns and horizontal rows are now in the process of consuming and competing with one another. This is a dynamic that incumbent firms need to understand.

1. Erik Brynjolfsson and Andrew McAfee, The Second Machine Age, W W Norton & Company, 2014
2. See Douglas Neal et al, A Guide to Co-Creating Value with Your Customers, LEF, January 2015


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