We are in the middle of a paradigm shift in the way in the businesses are conducted. The traditional model is increasingly being replaced by business ecosystems, dynamic independent partners that work together to deliver integrated products and services.

Today's business ecosystems are built around digital platforms. Our phones, cars, homes are increasingly being digitally managed. We are ordering food, groceries, transport, accommodation digitally. Companies are using the IoT Platform to increasingly drive their business. 

The digital systems provide access to capabilities that may be too expensive or time-consuming to build within the firm. It can scale up easily, are flexible and resilient, their modularity enables both variety and capacity to evolve. 

However, most start-ups' do not sustain over the long run and the success rate is only 15%. Why do they fail and how to increase the success rate.

Why are successful ecosystems so rare?

Ecosystems and digital platforms require a new mindset. Boundaries between industries are dissolving as incumbents are attacked by technology and digital platforms that they had never considered before. Organizations need to move from controlling internal resources to publishing external resources, to engaging communities, and move to collaboration and persuasion.

It is not enough to create value creation and delivery models. Designing a successful ecosystem poses multiple challenges. They cannot be completely planned and designed, they continuously evolve. So the design should ensure that the basics are covered and leave room for creativity, discoveries, customer needs. They should be ready to modify their design in anticipation of a shift in the markets, technologies, regulations, and public sentiment.

They also face challenges of building supplies or demand, keeping costs under control, protecting quality, defending against competitors. Many ecosystems are driven by strong direct or indirect effects and have a winner takes all characteristics. They require heavy investments upfront to build the platform and attract a critical mass of suppliers and once they take off they can scale up very fast at a very low marginal cost. Focusing on scaling up before profit means that failure becomes apparent after a significant delay. Also, herd mentality fosters imitation and apply the models to domains where they do not apply. 

To address these challenges we need to learn from failure, understand better the root causes, and identify the traps.

How do ecosystems fail?

Business failure is a result of a variety of external circumstances and internal decisions. On analyzing the reasons, there were seven distinct reasons for failures were identified. Most of the reasons (6 out of 7) were due to insufficient adaptation of ecosystem design. The seven failure reasons identified were - 

• Insufficient problem to solve The problem identified was not big enough to justify upfront investments. The value proposition is a function of the size of market friction it addresses, the share of friction that can be eliminated, and the price that the customer was willing to pay. Many B2B platforms failed when it tried to replicate the success of the B2C platform. They did not realize that the high transactional cost in B2C was not as pronounced in B2B as the industrial buyers knew their potential suppliers very well. 
• Wrong ecosystem configuration Once a substantial problem to solve was identified, the problem was to configure the ecosystem to deliver the value promised. This required defining the activities, partners' responsibilities, assigning roles to partners, defining rules and standards, and resolving conflicts. many projects failed on this count as they could not align all the required innovations or they could not convince all partners to join with the ecosystem.
• Wrong governance choices This was the most prevalent failure reason. Governance is most critical as it replaces the traditional hierarchical model. Governance establishes standards, rules, and processes that define an ecosystem. It needs to regulate access, participation, and commitment. The biggest challenge is to find the right level of openness, more open systems can benefit from faster growth but they are difficult to control. A moe closed system can be managed better as it allows a more deliberate design of the ecosystem, partners, and quality of service. many businesses failed because they opted for a high degree of openness.
• inadequate monetization This defines what and whom to charge. The business must balance the three competing objectives of increasing the overall size of the market, enabling partners to earn a decent profit and capturing its fair share of the value. This was more in B2C marketplaces.
• Weak launch strategy A strategic challenge is to solve the problem of securing enough participation from both buyer and seller. Success factors include focussing on the core value, building a minimum viable ecosystem, and then expanding over time., focussing on a dense network than a wide network. 
• Weak defensibility Once an ecosystem achieves a dominant position, strong barriers to entry can result in network effects and scale advantage of cost and data. Some factors that weakened their position were:
• suppliers/customers participate in multiple similar ecosystems and switch between them.
• partners bypass the platform and transact directly
• a subset of users have distinct needs met by another ecosystem and takes away market share.
• successful ecosystem expands into a neighboring domain.
• a backlash from incumbents, suppliers, customers.

Successful ecosystems respond by locking in customers, suppliers, incentivizing them for loyalty, increasing switching costs, and designing their systems for long term social acceptability.

• Bad execution This could be due to external factors like hacker attack, management misadventures, outright fraud, complacency. 

When do systems fail?

The nature of many ecosystems where the winner takes all means that failure may become apparent only much later n the lie cycle and can be costly. A typical life cycle consists of four phases

• Launch phase focusing on a strong value proposition for all players.
• Scale phase with a focus on increasing the numbers and the intensity of interactions for growth.
• The maturity phase focusing on increase the loyalty of customers and suppliers and erecting entry barriers.
• Evolution phase with a focus on expanding the offering, and continuous innovation.

Many of the ecosystems failed during the scaling-up phase when the design flaws became apparent and they collapsed. 

Some failed because they did not solve the chicken-egg problem and due to the wrong level of openness. In the maturity phase, there were many failures due to execution problems, governance issues.

What can you do about it?

Business ecosystems, built on digital platforms are new. Traditional management systems are insufficient to address their issue. We should learn from the success and failures of previous ventures and increase the odds of success. 

This checklist would help you access the vulnerability of your business. Of course, the ecosystem cannot be entirely planned and it should be adaptable and modified to suit the requirements of the markets, technology, public sentiments, and regulations. This checklist could help you challenge the viability of your business model and if found inadequate adapt the design or close down without any further investments.

Why Do Most Business Ecosystems Fail?

By Ulrich Pidun, Martin Reeves, and Maximilian Schüssler

BCG June 22, 2020