I was recently asked to help provide the business justification for a combined developer and partner program which are specific examples of business ecosystems. A lot of companies simply make a leap of faith when they decide to build out a particular business ecosystem — they subjectively believe in the industrial logic and subsequent value of program that they roll out. But this task was different, I needed to figure out how to quantify the business value of the ecosystem. Being a big believer that anything can be measured, I jumped at the challenge.
What I want to share with you is not the specific details of the cost justification methodology that I came up with, but the concepts behind the approach that I took; the approach is a bit different.
Traditional Return on Investment (ROI) calculations look at the cost of a project against any future cost savings and/or incremental revenues that might stem from the project. We map out the cost of the project versus the benefit over time and we then calculate the Net Present Value (NPV) of the resulting cash flows discounted by our cost of capital; the larger the NPV the greater the value of the project. The problem with a traditional NPV approach is that the industrial logic and strategic benefit of the faith leaper is ignored; for example, NPV does not consider that the ecosystem is critical to our company’s survival. In short, these business ecosystems are in this category of strategic initiatives that don't do well with NPV calculations and thus the challenge was how to quantify the strategic.
Let’s take a step back and look at things from 50,000 feet by starting with common understanding of terms and concepts:
If you look at the illustration above with your product (or service) in mind, you see that your product probably is not really ready for instant use by any customer; your customers probably need additional products and services that you don't provide to get value from the use of your product. For example, a PC is not much use without software and PC maker don't provide the software. Think about the 3rd party products and services that are needed to give your customers immediate value from your product and you start to see why a partner ecosystem is strategically important; it makes it easier for you to earn revenue. This is what Ted Levitt of Harvard Business School was speaking about when he coined the term the Whole Product.
When the IBM PC hit the market, Lotus 1-2-3 was the killer app that turned the PC into a whole product and thus made it of value and compelling. When the Mac hit the market, Aldus PageMaker was its killer app that made it a whole product and thus compelling. But the days of the killer app are long gone because technology markets are now too large and too pervasive to succeed on a single killer app. Besides the value of a computer (or smart phone) is that they can be repurposed by adding new software apps.
Fast forward to the success of the iPhone. The iPhone success started with iTunes which provided tremendous choice to satisfy any musical taste but that was quickly followed with the iTunes App Store which provided a choice of apps to make the iPhone even more compelling by making it a more valuable because it now solved more problems for the consumer. No matter how trivial the task, there was an app for that! What made the iPhone compelling to buyers was the choice offered by iTunes and the App Store. The iPhone succeeded because Apple realized that the day of the killer app was long gone and had been replaced the killer basket of apps. Each customer had their own unique set of apps that makes the iPhone killer to them and them alone. Choice from a large set of options that can be mixed and matched rule the day.
What makes any technology truly valuable today is that each individual customer can pick and choose the 3rd party plugins and apps that make it compelling uniquely to them. This is a new spin on the concept of mass customization – it has become mass self customization. To make your technology product really valuable you need a wide and robust selection 3rd party plugins and apps to enable each customer to build their own killer basket of apps. If you get this right, not only does it make the initial purchase of your technology compelling but it keeps our customers hooked and creates a barrier for that customer switching to one of our competitors. Because of the barrier to competition, the company that is first to market with this degree of choice for customers will become the Gorilla in the marketspace with strong competitive advantage. And is it this ability to capture a competitive advantage that is the true value of a developer and partner ecosystem.
Some business models might also have some direct revenue associated with their ecosystem because they charge for access to their developer tools, charge for membership in their partner program, or have app stores that sell the 3rd party apps directly to their customers from which margin is derived. How valuable is that revenue? A simple NPV calculations will tell you that, but that approach misses the other source of value; the value of becoming the gorilla that dominates your market segment.
We need a modified the approach to calculate the entire value of building a business ecosystem for it is not only the cost that we can shave or the amount of new direct revenue that we can generate (although those are great goals) but it also the increase in the value our business that comes from achieving gorilla status within our market. The best way to measure this is to forecast the change that our proposed developer and partner ecosystem will have on company valuation.
The most common measure of company value is based upon Price Earnings (PE) Ratio. Although there are other metrics, the PE is the simplest metric to understand and the easiest to benchmark our company against since it is so widely published. It’s pretty simple, the value of our company is our earnings multiplied by our PE.
Because our ultimate job is to increase our shareholder value and we can only do that by increasing our valuation. And using a PE model, there are only two ways to get an increase; we increase earnings by increasing revenues and decreasing cost AND/OR we change the market’s perception of us thus increasing our PE.
Not all companies within the same industry segment have the same PE. The more valuable companies will have a higher PEs than there less valuable competitors because they have greater competitive advantage within the segment. Being the Gorilla in a segment (e.g., Apple, Amazon, or Google) means that investors place a greater value on the company in the form of a higher PE.
Michael Porter’s well known five forces model gave us a framework for understanding competitive advantage within any industry. Supplier power, buyer power, threat of new entrants, threat of substitution, and rivalry within the industry provided us with a model to understand if our industry was a good one to be in or not. But within in the technology industry, there is a sixth competitive force; partner power that unlike the other forces is not industry specific but rather company specific; it is driven by the quality of the company’s partner and subsequently developer programs. The most valuable technology companies in a segment are the ones that has a greater command of their partner and developer programs.
A strong developer and partner program gives us greater competitive advantage because it improves both our PE ratio and earnings (because of cost savings and direct revenue contribution). When we ignore the contributions that our ecosystems make to our PE ratio, we ignore a vital part of the contribution that it makes to our value. Thus, the basis for justifying the building of a developer or partner ecosystem is how it increases your competitive advantage, increases your company valuation, and improves your shareholder value.