Roy Levien: Internationally Renowned Business Consultant, Author

This week, Stephen Ibaraki, I.S.P., has an exclusive interview with Roy Levien, Inventor at Intellectual Ventures, an intellectual property fund, and the Manager and Principal of Keystone Advantage LLC, a strategy and technology consultancy.

His recent works have generated considerable interest including, “The Keystone Advantage: What the New Dynamics of Business Ecosystems Mean for Strategy Innovation, and Sustainability” (with M. Iansiti, Harvard Business School Press), and the article, “The Ecology of Strategy” (also with Prof. Iansiti, Harvard Business Review). The New York Times was particularly impressed with the “admiring stir” that “The Keystone Advantage”was causing in among those who study innovation, competition and corporate strategy; Strategy & Business Magazine selected it as the “Top Book in IT & Innovation for 2004".

Discussion:

Q:Roy, considering your tight schedule as an internationally renowned expert, we are very fortunate you had the time to do this interview. Thank you!

A: It’s always a pleasure to share ideas. Thank you.

Q: Contrast and then detail your association and history with Aldaron, Intellectual Ventures, and Keystone Advantage.

A: Aldaron is a private umbrella for a variety of undertakings, including my writing, while Keystone Advantage has, of course, a consultancy built around the core set of ideas discussed in my recent book with the same title. I find that these are merging now into a consultancy that takes a biological view and looks towards the future in a wide variety of domains of which business is just one. My work at Intellectual Ventures (IV) is unrelated. My role is as an inventor working on new ideas and shaping them into valuable intellectual property. IV has been covered recently in the press, both in a feature in Newsweek and MIT’s Technology Review, and frankly, I can’t say much about what goes on there, except that it’s a lot of fun. I work with the smartest and most creative people I know in an environment that’s a combination of being in Buckaroo Banzai or U2, and the early days at Microsoft. Strange but true.

Q: Keystone Advantage has two categories of clientele. Can describe these two groups and how you address their needs?

A: Generally I look for companies that can benefit from a rethinking of their place in their network. While they could be divided into two groups, firms that are smaller and trying to understand how they fit in to their ecosystems, and firms that are larger and have more influence on their systems and hope to get better at it, I don’t see them as that distinct. Both groups face opportunities and challenges that overlap. Another thing that unites the kind of firm I look for is that they eschew the conventional consultancy model in which armies of junior analysts bill hour after padded hour to work out and “operationalize” all kinds of fantastic plans that they present in endless PowerPoint. My model is that a day of intensive brainstorming with the right people is your best value. Beyond that, the client either has the capacity to run with it pretty much on their own, or there’s really not much hope in the first place.

Q: Whether it’s colonial empires, biological systems, or businesses such as eBay with their small number of engineers, there are hubs or smaller number of entities influencing larger networks. Can you discuss your concepts of sharing value, innovation, business ecosystems, and keystones?

A: This is the core of the argument we develop in the book. In a nutshell the idea is in almost all complex networked systems that evolve over time – whether they are biological ones, like ecosystems, evolving through a process of natural selection, or man-made, like firms, governments, cities, empires or other institutions – they share features in their structure and dynamics. One of these is that, when you look at them as networks consisting of nodes and connections between those nodes, certain nodes are inevitably much more richly connected than others. These hubs have a disproportionate influence on how these networks function – far beyond any measure of their physical presence in the system. They shape the way the system works. Firms that do this right, which I call “keystones” in analogy with their biological counterparts, have the potential to increase the stability and productivity of these systems by facilitating the flow of value though the system. Their privileged position lets them control how much value they extract for themselves, and how much they leave for the other members of their network. If they balance this right, they can enable and sustain a large and dynamic system that lasts a long time. And there are specific things they can do to achieve this. One of the most important is the creation of a platform – a set of tools, technologies, and standards – that makes it easier for other members of the system to participate and share the value they create with other members of the system.

Microsoft is an excellent example. They have a huge influence on how the computing ecosystem works that is far out of proportion with any measure of their physical presence – number of products, revenue, number of employees. They achieve this through careful management of their position in the network of firms and technologies that constitute that ecosystem. Thinking about Microsoft in this way requires some refocusing, we are accustomed to seeing it as an ever-expanding dominating firm that crushes competitors that get too close to it, so it’s initially difficult to think of it as a small part of a much larger network. But if you take your eyes off the handful of firms near the core of the network that have been swallowed or crushed by Microsoft, and direct your attention to the fringes of the network you can see a pattern: for each firm that is crushed, many new opportunities are created elsewhere. This happens because Microsoft absorbs the functions of the eliminated firms into an expanding and increasingly capable platform on which others can really expand.

This is the same process that goes on in biological evolution: its capacity to build increasingly complex systems through integration. One living system absorbs and incorporates functions from others and thus gets more capable. That’s an important innovative process in evolution – at least as important as mutation, which generally gets all the attention. If there had been conventional anti-trust regulators around billions of years ago to cry foul when plant ancestors acquired (perhaps enslaved is even the correct term) chloroplasts, or when animal ancestors acquired mitochondria, then we’d live in a much simpler and less interesting world (actually “we” wouldn’t exist at all) – though perhaps a “fairer” one from the perspective of chloroplasts and mitochondria!

This process of evolution through incorporation (in addition to mutation) has parallels in business networks: integration in addition to invention. Integration is a critical part of innovation in such networks. That’s why it’s unfair to knock Microsoft for not being innovative. They may invent less than people think they should, but they innovate through integration, just as Nature does. This is a process that may not produce optimal or aesthetically pleasing results – Nature is full of “good enough” solutions – but it works and leads to rapid advance.

Q:Can you detail dominators traits including the areas of control and value extraction?

A: Dominators are the “bad guys” of this view of business networks. They exploit their hub position to extract value for themselves, leaving too little to grow or sustain a healthy network around them so that in the end they become the network. Dominators can also arise though mergers and acquisition or other anti-competitive practices, but the end result is the same: instead of a network with a large number of contributors sharing ideas and value, you have one or two big firms.

Q: Can you distinguish the ecosystem roles of niche players from dominators and keystones?

While keystones and dominators both sit at the hubs of their networks, but they manage them very differently. Niche players constitute the bulk of any network: they make the vast majority of products and account for the variety of what a healthy network does. They are specialists, using the tools and technologies that the network makes available as a foundation, so that they don’t need to reinvent the wheel and can thus focus on the things they do best. If I make toothpaste or board games or desk lamps, I can plug into Wal-Mart’s efficient retail platform and be assured that many decisions about distribution, shelving tracking and stocking – decisions that are not what I’m about – will be handled efficiently. If I make a financial software package or a PC game or an online music store, I can use Microsoft’s platform and tools to handle most aspects of interaction with the user, the hardware, and other applications and files. I can focus on adding my own value and am not redundantly creating things that are not only outside my own expertise, but which would make my product interact poorly with others if each niche player “rolled his own”.

Clearly it is the dominators and niche players who have an adversarial relationship: dominators are about displacing, eliminating, or absorbing niche players. But it’s not all love between niche players and the keystones either. This is one of the biggest challenges for niche players: they have to be pragmatic about their place in the network. If they are too close to the keystone, making something that is a candidate for incorporation into the keystone’s platform – like Netscape or Real with respect to Windows – they will end up in a high stakes game of survival. If they survive, they may, in effect, own a piece of the platform, thus becoming a keystone in their own right; if they lose, they lose completely. But in a healthy business ecosystem, new niches are being created all the time. Because the platform is constantly acquiring new capabilities, you can go, in a few years, from a situation where getting any sound out of your computer is a chore and where connecting with another computer requires a degree, to one where kids can acquire and listen to just about any music they want with the click of a mouse. Music players, something once considered inconceivable, now represent a hotly contested niche. But because the platform is evolving, it is also target for incorporation into the platform. That is one of the toughest things to accept about the dynamics of business ecosystems. Unless your niche is relatively secure and small, you will eventually end up as a candidate for incorporation into the platform. And that can be a boon or a bane, depending on how you prepare for it. Protecting your intellectual property and establishing yourself as a keystone in your own domain are critical parts of that. So is timing: Vermeer Technologies’ sale to Microsoft is an example of how to time things right; Netscape is an example of how to time things perfectly wrong. Vermeer knew that it wasn’t quite a keystone in its own right yet, but knew that it had technology that was going to be an essential platform component in the near future. It negotiated on that basis and the result was a win-win situation. Netscape thought it was a platform when it wasn’t even close to being one: it saw the potential, but was nowhere near actually embodying it. It acted on the basis of its delusions and died.

Q: You have particular views on outsourcing, innovation and its implications; and also about the origin of ideas. Can you elaborate?

A: Ideas come from people, not firms. Big in-house R&D is largely a waste of money. I’ve mentioned that innovation encompasses both new ideas and the combination of ideas in novel ways. Firms and networks of firms can be very effective at achieving this later kind of innovation, a process that we discuss a great deal in the book; but ideas themselves are quite different. They generally come from a very small number of individuals, often working on their own or as part of a creative team with unique interpersonal dynamics, history, and experience. Managers and corporate structure make essentially no contribution whatsoever. That’s a hard pill to swallow, but most managers just come from a completely different culture and hinder rather than aid the growth and development of ideas. To the extent that the idea market can be taken out of the corporate setting and returned to people, everybody – especially those with the ideas – will benefit. Networked business ecosystems enable this process like never before, by making it easier for a product to be assembled in a distributed way from ideas, components and technologies. These may come from a wide variety of sources, even from individual or small groups outside the normal corporate structure: in short, “outsourcing” of ideas by using the network to innovate. Ironically, just as we are increasingly able to make this a reality, and transfer power for the creation of ideas to individuals, there are movements afoot to steal the rewards for those ideas from people. 

Q:Can you forecast other niche winners for 2005/2006 such as Nvidia and Intuit from the past? Please provide some commentary.

A: Everybody who asks me this question wants me to say Google or EBay. But that’s not how it will turn out.

EBay, maybe, if they can see themselves not as a marketplace for things, but as a platform for the exchange-mediated communities. What does that mean? It means a system for bringing people together based on something that one person can transfer to or share with others. Sounds like a marketplace, and it is, but not in the narrow way that EBay currently conceives it. The “items” could be ideas, poems, songs, dates, photos, rendezvous – anything. You can see EBay users trying to push things in this direction with some of the unusual “items” they post, but EBay has been slow to respond with any meaningful changes to the capabilities of its platform. What they need to do is refocus on the communities that grow around these exchanges and the specific features that they will need. If they succeed they would become the platform for every kind of mediated interaction between people that involves something; it’s that general and it’s that big. A critical piece of that is to stop thinking of themselves a website and begin building a platform that can be embedded everywhere, from phones to kiosks to coffee shops: EBay-enabling these things would enhance them in ways that make them more effective in matching people with things and with each other. I don’t see this EBay-enabled world happening soon given their current course; fortunately they have the advantage of not being on Microsoft’s radar, so they have time.

Google doesn’t have that advantage – and they really don’t get it. Charles Furguson (of Vermeer Technologies, which was sold to Microsoft in 1996 to form the foundation of some of its Web technologies, most notably FrontPage), in a great recent analysis of Google’s future challenges in MIT’s Technology Review summarizes their situation by saying that they “will need brilliant strategy and flawless execution simply to survive.” He’s right. Right now, Google is the best search engine by far, along almost every dimension; and they are establishing connections between search and all kinds of interesting directions that enhance its usefulness and power. None of that matters though if they don’t work furiously to establish themselves as a keystone in the ecosystem of which search is the hub. I didn’t say “search ecosystem”, because that’s not the point. The point is to build an “architectural empire” by defining standards, protocols, and application programming interfaces – a platform for finding things, and for all the activities and associated services and processes that accompany finding things – everywhere. Microsoft already has a headstart on a lot more of this space than Google investors seem willing to admit to themselves, and they have tremendous success at building platforms. A lot of this space is unoccupied too, but the rush is on and Microsoft is a fierce opponent, and one that is more sophisticated at this game. My money is on them.

Of course there are other, less visible firms of all sizes turning their niches into ecosystems of which they are the keystone – we can talk about them another time!

Q: IBM has adopted a Linux strategy. Can you share your views on this?

A: Far more is going on there than meets the eye. This is part of what I alluded to earlier when you asked about innovation and ideas. On the surface, IBM appears to be endorsing Linux as a simple competitive tool: to hit Microsoft where it hurts and to leverage something that is basically free to them to enhance the value of their hardware and, increasingly, services. But what’s actually going on is much more subtle and pernicious. IBM is using Linux to establish itself a keystone in the Open Source software ecosystem. By endorsing Linux and Open Source, and by releasing some of their own patents into the ecosystem, as they have done recently, they are doing more than “reduce costs”; they are also undermining the value of intellectual property, on its own, creating an ecosystem where the intellectual property, for the most part, only has value in the context of their hardware and services products, which they can now produce at lower cost.

In this process they are aided by the Open Source ideology. There must be some axiom somewhere that says that any ideology – democracy, socialism, communism, whatever – is ultimately co-opted by established powers. That’s the real story of IBM and Linux. The Open Source community, and the anti-intellectual property movement with which it is linked, is so blinded by its ideology that it has become an accomplice to IBM’s plans.

This process shifts power away from people (who at least have the potential to file a patent and establish ownership of intellectual property) towards large firms. Firms, after all – if they are serving any purpose whatsoever – are more efficient at doing everything that an individual could do alone, so all that individuals have is their ability to create. When you render that valueless, the result is a geologic shift in power from individuals to firms. That’s ironic, even tragic, considering what the Open Source and the anti-patent movements stand for, but it’s what’s happing.

Q:How do companies go about understanding their dependencies, relationships, identifying critical assets internally and externally, and building strength throughout the business ecosystem?

A: In almost all cases where keystones have managed this, it comes from a deep understanding of how the technology of their network functions. Technology in the broadest sense: how all the pieces fit together, how things interconnect, which parts are essential, which parts are most valuable, where standardization helps, where it is unnecessary, and how these things change over time. IBM, for example, shows that it understood when they “gave away” those patents. Doing so encourages people to use them, to incorporate them into their products, and to accept them as part of the DNA of their own technologies. It also makes it easier for products from other firms to interoperate with IBM’s – in short, it draws them into the IBM ecosystem. But you can be sure that IBM has other patents that it will assert against these very companies to keep them at bay. If they know what they’re doing, they’ve taken a hard look at what they have and have said: if we give these away on the one hand, we will greatly enhance the value of these assets on the other. Doing that right requires a pretty good intuition about how everything interacts.

Q: Why should antitrust policies be rethought?

A: Conventional anti-trust thinking still has a role: to protect consumers from unfair pricing or limited choices. Typically that means coming down on firms that are exceptionally large relative to their industries, but in a world where the term industry is hard to define clearly, this becomes problematic, so you have to have a pretty deep understanding of how networks of products and firms fit together before you go mucking around with antitrust remedies. This is something we talk a lot about with respect to Microsoft. Microsoft has a lock on the desktop operating system market; but is that bad? Are they abusing it to harm consumers? Simple formulae no longer apply here because there are significant benefits to connected products hidden, as it were, in the price paid for Windows and in the “cost” of not having an alternative operating system to choose from. Another thing to consider is that if you accept our biological view of business networks, whatever you do to take down the leading player in a such a system will only be temporary: their occurrence is inevitable, so all you get is a costly disruption and an eventual return to the same structure. Different players maybe, but the same pattern. That means policies need to get away from trying to change this structure, and move towards a regime of trying to work with it and the dynamics it creates. Put simply, this boils down to enhancing the things that are good about it (like standardization, predictability, stability, etc.) and confronting the things that are bad about it.

This last part is actually the hardest, mostly because we labor under some false axioms about what’s bad: lack of “choice” and the related barrier to entry for new firms in certain domains. We need to get away from thinking that these things are inherently negative. How many digital media formats do I need? Is it okay to have a mediocre web browser that does 90% of what I want, if it means that developers can target a single well-understood platform? There are complex trade-offs here that need to be examined closely, case by case, and not subject to some reflexive application of assumptions about “competition”.

Some things about keystones, though, are inherently dangerous, and can only be addressed with some kind of intervention. Wal-Mart is a great example. They create all kinds of efficiencies that benefit many members of their ecosystem; that’s their area of expertise. But they are terrible at other things, like architecture, landscaping, and aesthetics. Because of their powerful position, almost every one of us has to deal with their bad taste and incompetence in these areas. Microsoft has a parallel problem; they make great operating systems, great API’s, powerful productivity applications and superb tools, but they have some of the worst user interface design in the software universe. Ideally, in both these cases there should be a way to leave the valuable platform aspects of the firms intact, but to intervene to prevent the damage they do in areas where they lack competence.

Q:Your views on Enron, Apple, AOL are enlightening. Please explain?

A: All three are examples of firms, that in different ways, failed to employ their central positions in their networks in ways that were effective. We talk about them at length in the book.

Instead of serving as keystones, they each acted as a dominator, each to a different degree and a different mode. Enron is the most spectacular and well-known example: it served as a kind of “value dominator”, a usurious landlord on the whole system of energy delivery and trading. All of its activities – indeed all of its considerable cleverness and creativity – was focused on extracting value for itself, not on creating it or on allocating it in ways that sustained the ecosystem. Enron became the ecosystem, dominating every valuable aspect of it and at the same time it destroyed its capacity to create new value. We know where that led. AOL did the same thing to a degree: it extracted high rents from its “hub real estate” and ended up draining it right out of the ecosystem that they ought to have been helping to start. During the dot-com heyday, they had startups handing over huge chunks of the capital they raised directly to AOL as price of admission to a system that never got off the ground, largely because of AOL’s greed. Both Enron and AOL are examples of firms that acted as if they failed to appreciate the important role that a network hub can play in the health of an ecosystem.

Apple is a slightly different case: they missed a huge opportunity to start a healthy ecosystem because they were so focused on the quality and greatness of their product that they didn’t think in terms of the possibility of establishing an ecosystem around an architecture. This wasn’t an issue of competence: Apple had a superb architecture including all the right pieces – their APIs and the famous “Phonebook” that describes them were works of art. But they couldn’t take the business decision to run things on a longer leash and live in a slightly less orderly but more dynamic world. That’s precisely the decision Microsoft made and it’s why they are so much more valuable and influential than Apple today, 20 years on.

Q: Can you detail future papers and books that we can expect from you?

A: I’m working on two books. One,"Resistance is Futile" that focuses on the implications of evolutionary processes for the way our institutions and organizations evolve. In a way it’s a broadening of the very narrow focus of "Keystone Advantage" to encompass other arenas – political, social, economic, technological, and cultural – and to address other issues, such as our relationship to the institutions we create and the extent to which we control them. In parallel I’m working (at a glacial pace) on a science fiction book, "Exodus 2", which deals with the same things. Don’t laugh.

Q: If you were doing this interview, what two questions would you ask of someone in your position and what would be your answers?

A: That depends on what you think my “position” is, and on who’s asking the questions.

The critical question, I think, for most executives in firms of just about any size, is “where do I sit in my business network, what are the limits and what is the potential?” If Netscape had asked this question, it would still be a going concern. If Apple had asked this question at the right moment, there might never have been a Windows. IBM asked this question recently, and they are changing the software landscape. The answer, of course, is different for every firm, but the critical thing is to be realistic about where your opportunities lie, and to be willing to rethink your business as a participant in a network of products and services and technologies, rather than as an isolated firm making something that stands alone. That means accepting that you have dependencies, often on things you cannot control; and to be pragmatic and proactive about balancing the good and the bad that comes from this. There are efficiencies that come from leveraging the platform, pitfalls of dependency – and potentially huge opportunities for making some aspects of what you do essential for many others in the network.

More generally, a critical question that just about anyone could ask is “what are the broadest insights from your work to policy, economics, and society?” I’d say that the key insight there is that biological forces are at work at all levels of complexity. We have a tendency to draw a line between life and non-life, and between one system and another, and to think of ourselves as somehow being in the driver’s seat. But that’s just not how things work: we are embedded in systems that are changing all the time, subject to their own dynamics; we often simply don’t have collective access to the levers that control these systems (think traffic jams!) but even when we can acquire some God’s-eye perspective – through regulation or legislation – we can’t change the fundamental ways in which they work. That realization is that it’s not just important for business decision-makers.

Q: Roy, we are so fortunate to have your share your accumulated business acumen with our audience. Thank you!

A: Thank you. My pleasure.