Chapter 3: Extending the Enterprise
Focus of chapter—business networks (ecosystems) within which people and partners work
together to achieve shared goals.
I. Understanding Business Networks
Organizations and the industries and markets within which they operate can be defined as networks
of specialized nodes (units) that work together to achieve a common purpose.
Two overarching design goals must be considered in the design of business networks, either intraorganization or across organization boundaries:
 Differentiation—how individuals, groups, and organizations are subdivided into specialized
work units (nodes), in one of the following ways…
o Horizontal diffusion of work into specialized operating units
o Vertical division into power/authority levels
o Spatial division into geographic or product groups.
Differentiation enables a network to manage complexity, develop specialized expertise and
assets, and focus attention and resources on accomplishing specific goals and tasks.
 Integration—the relationships between nodes that are required to unite specialized
individuals, units, and organizations to achieve a common purpose and create shared value:
o Task-based relationships unite individuals, groups, or organizations that work
together or sequentially.
o Information-or-expertise-based relationships unite individuals, groups, or
organizations that provide information or expertise required by the network.
o Social relationships unite individuals, groups, or organizations to enable them to
develop strong bonds of affiliation and identity.
Sociologists say: stronger, deeper network relationships are required in environments with:
 Increased complexity, uncertainty, and turbulence—particularly when a large number of
highly differentiated nodes must work closely together to achieve a common goal.
 Increased task interdependence necessary to:
o Produce customized products or deliver shared services
o Develop and deliver innovative and creative products, services, and solutions.
 Increased information/expertise interdependence necessary to:
o Share large amounts of real-time information.
o United the perspectives of various actors to make sense of the information to support
decisions and actions.
 Increased social interdependence necessary to:
o A large number of divergent subcultures that must develop shared beliefs and a sense
of trust to work together.
o Incentives that reward cooperation and collaboration across highly differentiated
subunits.
o Leader preferences for shared vision and values.
Challenges:
 Network relationships are stronger among people in close physical contact and most alike.
 However, network performance in complex, uncertain, turbulent environments requires a
dense network of diverse specialized assts and the ability to quickly/effectively deploy those
assets to create value for all members and the network as a whole.
 Redundant relationships that lead to the same resources may decrease risk and increase speed
of leveraging and using resources, but are more costly.
Execs face 3 major categories of decisions: (discussed in the following sections of the text)
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1) network differentiation and unit groupings
2) network integration and interdependencies
3) network ownership
A. Framing Decisions Concerning Network Differentiation and Unit Groupings
Differentiation—the logic behind the choices that execs make when combining different
activities, resources, and capabilities into unit groupings.
Unit grouping decisions are often tied to functions that need to be performed, products or
services that need to be developed, and/or customer or geographic markets that need to be
served.
Key decisions include:
 What are the key capabilities and resources required to execute strategy and achieve our
goals?
 What activities must be performed to acquire or build those capabilities and resources?
 How should these activities be grouped within specialized units (network nodes and subnets)
to focus attention and resources on the development of best-in-class proprietary capabilities
and to most efficiently and effectively accomplish goals?
Table 1 (p. 83) shows that:
 Decisions concerning unit groupings are based on decreasing the costs/risk of coordinating
and controlling activities within a specific unit groups by enabling groups of people
performing the same tasks and using the same resources to work closely together.
 Within a single unit, individuals may set goals and coordinate, and control work through
direct, face-to-face communications and actions or through a combination of face-to-face and
technology-mediated communications and actions.
 More complex units (like a division or organization) may use more formal organizational
solutions that involve process design and authority, planning, budgeting, performance
management, and incentive systems. These formal organizational solutions may involve both
face-to-face and technology-mediated communications and actions.
B.
Framing Decisions Concerning Governance of Interdependencies
The next set of decisions is about the interdependencies and relationships among the different
nodes. This process is actually a “messy” one, with one decision influencing decisions made
earlier and later in the process.
Key decisions include:
1. What are the key task, information/expertise, and affiliation/identity interdependencies that
must be managed between specialized units located inside and outside the organization?
2. What organizational solutions are needed to coordinate and control key areas of
interdependence among specialized units?
3. What configuration of organizational solutions should be used to ensure alignment and fit with
the business environment and strategy to enable the network to fulfill its common purpose,
achieve shared goals, and create value for all stakeholders?
Important principle of network design: the choice of organizational solutions for integrating,
coordinating, and controlling interdependencies and relationships among differentiated units
depends on the context within which an organization operates.
In the 20th century, three inter-organizational governance models—markets, hierarchies, and
partnerships—emerged to meet the integration, coordination, and control challenges associated
with different contexts. (see Table 3.2):
 Market models of governance:
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o Simple and short--involving the exchange of goods, services, and payments, during a
specific time period and with limited interaction of information sharing between the
parties involved.
o Affiliation/identity is related primarily to repeated purchase, use, and experience with a
product or service—not to strong direct face-to-face interactions between suppliers and
customers.
o Ex: Procter & Gamble and the consumers that use its products.
Hierarchical models of governance:
o Best suited for complex, but routine work.
o Formal contracts and authority define the activities to be performed, products/services to
be provided, price to be paid by each party, and length of the relationship.
o Contracts are well-defined, clearly documented, and define responsibilities of each party,
coordination of exchange of goods and information, and the nature of the
interdependencies.
o Ex: Joint ventures, in which two or more firms become an equity owner of a legally
defined entity.
Partnership Governance models:
o Hybrid form of governance, required when the interdependencies among specialized
units are complex, uncertain, and critical to the success of the firms involved, and neither
market nor hierarchy governance models is sufficient.
o Required shared goals, complementary expertise and skills, high levels of trust among the
parties, and networked integration of processes and work across organizational
boundaries.
o Exchange of goods/services is ongoing, and the interactions/relationships must adapt to
changing priorities, needs, and expectations of parties involved.
o Long-term partnerships often require significant investments in interactive governance
systems (joint boards, product councils, operating committees, and information and
performance monitoring systems) that are used to carryout, coordinate, and control
densely networked and interdependent activities.
o One-on-one personal interaction and trust develop over time.
C. Framing Decisions Concerning Network Ownership
Three dominant forms of ownership models within subnets of a complex business network:
 The majority of specialized units may be located inside a corporation or other legally
defined organization.
 An alliance may be formed between two (or a small number of players.)
 A diverse community, called an ecosystem, of players, representing different roles
(suppliers, distributors, buyers) may work together to achieve shared goals.
Figure 3.1 on p. 87 is a framework for categorizing business networks based on ownership and
governance:
 According to Fig. 3.1 (a), in the industrial economy business environment of the first half of
the 20th century, exec decision making favored corporate ownership of all but the most
simple, transactional activities that could be governed through market mechanisms or
structured contracts.
 In the late 1980s and the 1990s, hybrid forms of governance emerged and features of a
partnership-style of governance became more prevalent, as firms formed alliances across
organizational boundaries supported by EDI (electronic data exchange).
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Alliance membership tended to be limited to organizations that shared the same proprietary
technology (EDI and inter-organizational transaction processing systems). Ex: American
Airlines’ ABRE system, American Hospital Supply, and the NASDAQ Securities Exchange).
These organizations became the model other execs used as they began to use the Internet as
an open, nonproprietary platform for sharing information and conducting business during the
late 1990s.
See Appendix 3a, pp. 100-106 for a taxonomy of emerging network business models of the
late 1990s:
o Two primary categories of network business models1. Businesses being built and launched on the Internet B-to-C models (Amazon.com, Landsend.com), C-to-C models (eBay,com),
C-to-B models (Priceline.com), B-to-B (Ex: FreeMarkets, Global Healthcare
Exchange)
 Distributors-enable buyers and sellers to connect, communicate, and transact
business. Ex: eRetailers (Amazon.com); eMarkets (Global Healthcare Exchange);
eAggregators (InsWeb); infomediaries (Internet Securities); Exchanges
(NASDAQ, eBay).
 Producers-package the work of creators into products, services, and solutions that
meet a market need. Ex: Manufacturers, Service providers, educators, advisors,
news services.
 Portals-aggregate products, services, and/or information Ex: America Online,
Google, CompuServ
2. Businesses that provide the digital infrastructure-venders and service providers
that provide IT infrastructure products and services directly to business customers and
consumers (IBM, Hewlett-Packard, Cisco, Lucent, Dell, Microsoft, Oracle)
 Horizontal portals—Internet service providers that provide gateway access to
network, data center, and web site/online business hosting services.
 Vertical portals—application service providers, who host and maintain a software
application, so that businesses and individuals can conduct business online.
The emerging network business models of the 21st century represent a wide range of
ownership and governance structures:
o Citigroup is a large, vertically integrated corporation –an intra-organizational
business network composed of differentiated product, market, and geographic units.
o American Express Interactive is an It-enabled alliance between American Express
and Microsoft.
o Increasingly prevalent are hybrid governance models called collaborative
communities, which combine features of a market, hierarchy, and partnership, and is
often supported by a sophisticated IT infrastructure that enables real-time, interactive
integration, coordination, and control of task, information, and at times, even
relationship interdependencies across firm boundaries. Ex: Global Healthcare
Exchange, Covisint, NASDAQ.
II. Designing Hybrid Governance Models
According to traditional economic theory, governance decisions are a choice between markets and
hierarchies.
Markets – principles of supply, demand, and pricing are used to coordinate and control the flow of
goods and services across legally defined entities.
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Hierarchies—structure, systems, and authority are used to coordinate and control the flow of
goods/services inside a legal entity (an organization, a joint venture, or a contractual relationship).
Markets vs. Hierarchies-According to transaction cost theory, markets:
 optimize lateral information sharing among peers.
 lead to great efficiency and effectiveness, unless the cost and risk of using market
mechanisms to coordinate and control interdependencies are higher than the cost and risk of
hierarchy.
Cost and risk in market forms of governance include:
 Need to duplicate costly, proprietary assets that cannot be easily leveraged/shared across
organizational boundaries.
 Need to settle frequent disputes among parties in a transaction
 Increased cost and effort related to access and validation of information concerning
transactions and price
 Need to join with others to increase market power.
When conditions for market failure are high, hierarchical models of governance are an alternative:
 Hierarchies optimize vertical information processing.
 Unified ownership and authority focus attention and resources on the pursuit of a common
goal.
 More efficient and effective than the market model when high levels of uncertainty or
inequalities in power increase the risk of market failure.
 Reduce instability and opportunism.
 Structure, standardization, incentives, and supervision ensure that individuals and units act in
best interests of execs and owners to achieve corporate goals.
 However, hierarchy can fail in turbulent, uncertain, hyper-competitive business contexts.
In the latter half of the 20th century, IT increased both vertical and lateral information processing,
leading to a new governance model—collaborative community, whose key features are:
 Shared purpose and values stress an ethic of contribution that replaces the uneasy coexistence
of loyalty and individualism in traditional intra- and inter-firm business networks.
 Organizational configurations and solutions support horizontal relationships among peers,
but do not preclude the existence of interdependent, vertical, authority-based relationships
and market-based transactions.
 Interdependent form of identity that motivates and engages active participation and affiliation
over time.
A. NASDAQ Securities Exchange: A Collaborative Community in Action
Example of an online collaborative community
Created in 1971 as an online securities market that enabled a widely dispersed network of
independent broker-dealers to trade securities on behalf of individual/institutional investors.
A diffuse, interdependent network. Uses a complex governance model that combines features of
market, hierarchy.
B. Laying the Foundation
Core operating process of a securities exchange—the buying and selling of securities and the
clearance and settlement of the transaction.
Specialized Units:
Issuers—companies that offer shares of securities for purchase or sale.
Investors—individuals and institutions that buy and sell securities
Broker-dealers—trade stocks on behalf of investors
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Clearance/settlement firms—ensure that payments are made, credited and ownership rights
transferred.
How NASDAQ operates:
 Automated online streamlining and integrating activities of the specialized units ensure
efficiency, consistency, and reliability of day to day operations.
 Information is generated that enables members worldwide to make decisions.
 Market-based governance is used to coordinate/control routine end-to-end processes.
 Common network infrastructure and common standards that enables dynamic
reconfiguration of the network to meet the real-time needs of buyers and sellers
(hierarchical-type of governance)
 Broker-dealers act as “network orchestrators” who unite buyers and sellers to enable them
to achieve the best price in the shortest transaction time
 Real-time info is captured and shared with members of the NASDAQ community, as well
as to those who are in charge of controlling the dispersed global network.
C. From Flawless Execution to Innovation
Other processes support innovation and growth of the network:
 Issuer support firms help issuers prepare public stock offerings, set initial stock prices, and
market the securities to broker-dealers and institutional investors.
 Investor support firms provide info and advice to investors.
 Technology Advisory Council (TAC) – for product innovation
These self-managing teams use a partnership-type of governance
D. Role of IT in Operating and Governing the NASDAQ Securities Exchange
Information transparency:
 promotes consistency and confidence in the repeated interactions among members
 enables members to learn how market dynamics link to positive/negative outcomes.
 NASDAQ has embedded standards and procedures into routine operations while also
supporting horizontal peer-to-peer transparency and trust—by allowing network members
to define agreed-upon standards.
E. Linking IT to the Evolution of Partnerships and Trust
3 Approaches for building trust:
 Process-based trust-emerges from recurrent transactions as parties manage task
interdependencies.
 Affiliation-based trust—rests on strong feelings of identity within a specific group.
 Institution-based trust—is tied to formal organizational and social structures.
Trust transfer can be provided through:
 developing a relationship with a trusted party who will vouch for the unknown party.
 providing verifiable evidence (observation, monitoring, info) of trustworthiness.
How NASDAQ used these approaches to build trust:
 NASD was formed by its broker-dealer member-owners—affiliation-based trust.
 The authority, duties, and obligations of NASD were defined and granted by its
members-institution-based trust.
 Agreed-upon processes, information-sharing standards, and controls were embedded in
information technology systems that all members would use—institution-based trust.
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Business was conducted online that consistently met the expectations of membersprocess-based trust.
III. Building Collaborative Community: Lessons from the Field
Throughout the 2nd half of the 20th century, advances in IT, coupled with the rapid evolution of
management theory and tools, made it increasingly easier for independent companies to
coordinate interdependent activities.
The rise of the “virtual corporation” (ex: Dell) —a network of focused businesses that come
together as free agents to design, build, market, sell, and support products and services within a
wide variety of old and new economy industries.
Proposed benefits—greater efficiency, increased responsiveness, the ability to share specialized
assets and to tap into high-powered market incentives.
Potential problem areas—increased inter-firm coordination costs prevent efficiency gains, lack of
trust delays adoption of shared standards and horizontal processes.
A. Key Insight: Hybrid forms of governance are emerging that unite hierarchy,
market, and partnership
Market and hierarchy, used together, can facilitate and enable collaborate capacity and trust.
Ex: Hierarchical governance mechanisms like standards, policies, and procedures can be
embedded in transaction processing systems that enable market-based transactions to take
place consistently, reliably, and efficiently.
Ex: Transaction information from market-based transactions can be captured and reported to
regulators to ensure compliance with policies and laws (hierarchy-based)
Ex: The same transaction information from market-based transactions can be made available to
teams of experts that join to develop highly customized, knowledge-based solutions/product
innovation (partnership-based).
B. Key Insight: A network orchestrator role is emerging to coordinate inter-firm
interdependencies within business ecosystems, like NASDAQ and GHX
A network orchestrator is required to coordinate task, information, and affiliation
interdependencies within business ecosystems.
NASD launched NASDAQ to be the orchestrator.
GHX was launched by the healthcare industry to be orchestrator.
C. Key Insight: Network orchestrators design organizational solutions that reflect
the interests of all parties.
A network orchestrator ensures that all interests in a buy-sell transaction are represented:
Board of directors defines directions, priorities, and oversees actions to ensure that collective
interests of members are supported.
D. Key Insight: Collaborative community and trust co-evolve over time
Trust begins when boards of industry leaders establish a governance framework that supports
collective action.
Authority is then transferred to a product council that represents all members in the
collaborative community, who develop common standards, procedures, and processes
(including It-enabled processes) required to coordinate interdependencies.
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