Take just enough

Greed spoils business ecosystems.  Open ecosystems are gift economies that depend on reciprocal care.  They require considering a situation from all sides. Get clear on a fundamental choice:  you can grow your business by growing the ecosystem and advancing the opportunities for your customer.  You can also grow a business — at least in terms of revenues and profits — by taking from your ecosystem and from your customers.  The philosophy of “just enough” is not about austerity.  Indeed, those in the connected community are thriving.  It is about caring for your partners, not “sucking the life out of them” by exerting your bargaining power when they are weaker.  It is about gaining your security and your enjoyment and your accomplishments with others — in ways that are sustainable as a business, an organization and a person.

Mentor Graphics, ARM Holdings 

Some years ago Laura Nash and Howard Stevenson wrote a fine and provocative book called Just Enough.[i] Laura teaches ethics at Harvard Business School and Howard founded and led the school’s program for entrepreneurs.  On the basis of observing the careers of former students over many decades, they concluded that the happiest are those who pursue “just enough” personal achievement, and then allow themselves to be interdependent with communities and families who enjoy and nurture them.  A “just enough” approach recognizes that individuals inescapably live in community, and that the natural course of a sustainable life is for a person to contribute to the community, and for the community in all its diversity and richness and care to help that person develop their gifts and live a good life.

The ecosystem-level business model of the connected community is precisely “just enough,” substituting companies for individuals, and the ecosystem for family and community.  Wally Rhines, CEO of Mentor Graphics, was one of the earliest leaders in the connected community, signing the second ARM license, after LSI Logic, in 1992 while at Texas Instruments. When he moved to Mentor Graphics he continued to be a partner.  He described how he and his colleagues gradually began to realize the full benefits of the ecosystem model:

“There were economies of scale associated with the ecosystem design that we didn’t recognize at the time, but became very important.  We did recognize the importance of an embedded software infrastructure and third party contributions.

“Supporting an architecture requires enormous resources.  Resources in design and verification and software development and support applications.  And really there haven’t been that many prolific architectures just because the amount of work is so large, and no one company can do it.

“The economies of scale came in having one company do it and a lot of other companies using it as a building block for creating more value in their particular designwhere they put a lot of additional logic around it and targeted it at specific market segments.”

“As a leader, is there a lesson in all this?” I asked. After a moment he replied,

“The first thing is to keep an open mind about contributions from other people and to be very parsimonious with your own time and resources so that you spend your time doing what you do best.”

“Is there a life lesson that you might want to pass on to your children regarding this topic?” I asked.

“The life lesson for my children is work at something that’s really interesting and changing and evolving because it’ll attract other interesting people.  They will do other interesting things and create opportunities and excitement for you in your life.”[ii]

“Just enough” yields “lots more.”

In business as in life there are things one does well, and things one doesn’t.  The theory is simple: with each party giving its best, the ecosystem as a whole gives its collective best.

While it is clear that this model is good for the whole if it can be maintained, an observer would ask what keeps stronger companies from preying on the weak? What keeps companies from consolidating key industry services like electronic design automation and denying them to others?

The answer is that leaders of the ecosystem are proactively shaping an ethos that encourages “just enough” restraint across the ecosystem, in the name of enabling closer collaboration, deeper specialization, and growing the whole.  Given a choice of growing a company alone, or growing an industry and an ecosystem, these leaders understand that they are linked, and they must do all three.

A “just enough” lifestyle is attractive to others in both business ecosystems and in community life.  It helps recruit talent and companies into the ecosystem, eases entry into new markets, builds customer trust and gives companies the security to more deeply collaborate.

In other ecosystems there is much talk of “lock-in” — of forced dependency.  In the ARM ecosystem the relationships are closer than I’ve experienced in any comparable ecosystem, but people talk of interdependence and community.  One day it struck me, the term “lock-in” arises when there is a fundamental break in the business relationship.  Otherwise the experience and the term is intimacy.

I had a recent discussion with Simon Segars on “just enough.”  Simon was employee number 16 at ARM, and will become CEO of the company on July 1st. He was quite clear on ARM’s partner-favorable policies.  I asked if he felt ARM was leaving money on the table and he said,

“Well yes, that’s a common question we get from investors, though lately less so. Maybe that is because we’ve been having the conversation for so long about it.

“Investors will sometimes say, ’You’re so, you know, strongly penetrated in a particular market segment.  What stops you from multiplying your royalties by ten?’

“So a great example of why we don’t do that is because we do want to see our technology deployed as broadly as possible and if we were egregious in our royalties because of the strength of our market, we wouldn’t have our customers taking us with them to other markets.

“So this pricing and relationship making has been a very strategic thing.

“In the ‘90s GSM [wireless telephony standard adopted Europe-wide] was making fast headway, and was associated with enormous markets.  This market could [in principle] be served by many people like us, and many people wanted to get in.  In our case our current customers had used our technology in many cases successfully, their engineers knew how to use the processes and they had good relationships with the company.  So when they looked at this new opportunity, it was an easy decision to choose ARM.”

Simon’s philosophy is that the ecosystem point of view is much more than just pricing, and that members of the ecosystem have a comprehensive strategy for taking care of others across it.

“We do value partnership as a core culture in ARM.  We work hard to be favorable to our partners and you know even though there are only 2,500 people in the company, spreading this philosophy across everyone sometimes gets hard.

 “We do treat our partners equally.  We do really try and play nice and we really try to build an ecosystem that is self-funded.  It’s been very important to us that our ecosystem partners can build profitable businesses of their own, and that we’re not just extracting all of their profits into our P&L.“[iii]

Simon used the polite term “extracting,” but across my interviewees the more common phrase would be “suck the profits out of the ecosystem” and the topic was top of mind for tech leaders.  The phenomenon is well discussed by Marco Iansiti in his book The Keystone Advantage.[iv] He emphasizes that it is very difficult for a strong ecosystem player to resist investor and other pressures to take profits away from others.  Essentially they do this by extorting high prices for their products —which are essential and unique — leaving little available profit for others.  The weaker have little choice once they are woven into the ecosystem — their revenues, which may be large — can’t be maintained if they try to get out. And the consequence is that the weaker players cease to innovate, and potential joiners to the ecosystem are scared away.

This is the narrative every single interviewee applied to the personal computer ecosystem today, noting that even though the PC ecosystem is declining, two companies continue to extract billions in earnings, and in the case of the other companies — mainly computer OEMs and ODMs — most are either just above breakeven or losing billions per year.

The connected community is designed to prevent this sort of behavior, and spread wealth around.  Three realities keep the ecosystem on track.  First, there is competition in the ecosystem in the vast majority of niches that keeps prices disciplined.  And in the case of places where, by necessity, the ecosystem needs one standard and one steward — as in the microprocessor design — there are rivals that could be turned to if necessary.  Every space in the segment is “contestable.”  Players are motivated to be pro-community, or the community can replace them.

Second, powerful players use creative financial terms designed to shift risk and immediate costs to the larger, stronger members — thus enabling weaker players to contain their costs so that they have their best opportunity to succeed in the marketplace.

The mechanisms are varied and inventive, and throughout they demonstrate a nuanced effort at balancing value in the ecosystem.  These mechanisms are very different from the alignment-gaining payments made from monopoly players to others in first-generation ecosystems.  In general the first generation payments distort payee behavior, reduce differentiation, and dampen market signals from the customer edge of the ecosystem.

In this third generation ecosystem, the mechanisms are designed to assist all of the weaker partners, without picking winners, to reduce their financial risks and costs in order to explore differentiated approaches to the market.  The goal is to have many partners listen-to and amplify market signals — and let as many as possible thrive.

As I went through my study I was presented with a variety of mechanisms.  Wally Rhine pointed out that semiconductor manufacturers have long practiced “forward pricing” where customers can buy a chip for what it will cost in the X millionth unit.  The strong manufacturer reduces the cost of a component, reducing how much its downstream customer needs to lay aside for chips, which lets cost and price reductions cascade down through the chain end customers, and when successful helps stimulate the market.

Frank Frankovsky of Facebook shared the information that he and other cloud services companies are looking upstream to server and network equipment companies, and offering to assure a future market if vendors work together on innovations of particular value to the services companies.  A similar initiative among communications carriers is called SDN, software defined network.  The carriers have come together to work with their suppliers.

ARM’s business model is based on tiny royalties paid when a chip is sold.  A customer of ARM’s pays a license and a royalty.  The one-time fee for a perpetual license for a processor design is priced on a sliding scale in order to be accessible to all.  Later, sometimes years later, when the licensee actually sells chips to its customers, it pays a small royalty per unit.  This second part of the agreement is a gain-sharing approach, and incentivizes ARM to help the customer be successful, for example providing extensive free consulting — because of course that is the only way it will get paid royalties.

Finally, powerful companies sometimes do seem to squeeze the others in the ecosystem, or at least shift burdens to them.  This can cause consternation.  The principle foundry TSMC, until recently, charged its customers only for actual working chips, and TSMC absorbed the cost of defective chips. Recently TSMC began charging for chips that come off the line, putting the customer at risk in case of poor manufacturing yields.  As time goes on it will be interesting to follow the response of the community to this move, which has special significance as TSMC moves to the advanced 14nm and below process nodes, where yields may be increasingly unpredictable.

What we see overall across the ecosystem is a leadership philosophy and practice designed to enable partners to focus on their special competences, work closely with others, listen to the market and customer, differentiate in the ways they think best, contribute to the community as a whole, and reap fair gains when successful.

By not exerting their market power against each other, and by employing well-designed gain sharing, this open ecosystem keeps average selling prices low and differentiation high.  This makes solutions available to the largest number of people, accelerates penetration of the market and improves the lives of more customers sooner. The point of the ecosystem is to transform the world, one customer and product at a time and to do so at a rate faster than comparable systems.


NOTES

[i] Just Enough: Tools for Creating Success in Your Work and Life, Laura Nash, Howard Stevenson, Wiley, 2004

[ii] Wally Rhines, Mentor Graphics, personal communication, April 2013

[iii] Simon Segars, ARM Holdings, personal communication, April 2013

[iv] The Keystone Advantage: What the New Dynamics of Business Ecosystems Mean for Strategy, Innovation, and Sustainability, Marco Iansiti, Roy Levien, Harvard Business Review Press, 2004