The Business Ecosystem: Value Created Outside the Firm

A business ecosystem is the set of participants whose activity makes a firm's offer more valuable while the firm neither pays them nor tells them what to do. Merchants who photograph their own goods, reviewers, trainers who teach a listing tool. The value arrives from outside the firm's legal edge, and nobody sent an invoice for it.

Underneath that sits one idea that has to be drawable before any of the rest is visible. A company has an edge. There is a line around it, and the line is not a metaphor: it is drawn by employment, by what the company holds, and by what it has agreed to pay for. Everything the company can command sits inside the line or is bought across it. An ecosystem is the activity that helps the company from the far side of that line without being commanded and without being bought.

Where exactly does a firm end?

The everyday version has the same shape, so start there. A tea stall on an office lane has a line around it too. Inside are the two people who work there and the stove that belongs to the stall. Across the line and paid are the milk supplier and the man who delivers the gas cylinder. Outside the line and paid nothing are the security guards of the office building who tell every visitor where to get tea, and the auto drivers who park there because they know a queue forms. The stall never hired them, never pays them, and could not stop them if it tried.

A firm's edge is drawn by employment and by payment, and an ecosystem is whatever helps the firm from beyond that edge without either. The observation is not new. Ronald Coase asked in 1937, in The Nature of the Firm, why firms have any edge at all rather than every task being bought in the open market, and the answer he gave was about the cost of arranging things. The narrower point is this: once the edge exists, it can be pointed at, and once it can be pointed at, every participant can be sorted by which side of it they stand on.

Take Setu Bazaar, an invented marketplace where small merchants list goods and buyers buy them. Rs 500 crore of goods pass through it in a year, and Setu Bazaar keeps 4.00 per cent of that as its take rateThe fraction of the money passing through a marketplace that the marketplace keeps for itself. How it is calculated, and why two reported rates usually cannot be compared, is a separate subject., or revenue of Rs 20 crore. Inside its edge sit three groups on its payroll: the listing and payments team, the customer support desk, and the engineers who run the site. Across the edge and paid sit three more: the delivery firms it contracts, the payment gatewayThe service that carries a card or bank instruction from a buyer to a bank and returns an approval or a refusal, usually charging a fee on each transaction it handles. that takes a fee on every order, and the computing capacity it rents by the hour.

Then there is a third group, and it is the one the word ecosystem names. Merchants photograph their own goods and upload the pictures. Buyers write reviews after a purchase. Independent trainers run paid classes teaching shopkeepers how to build a listingA single item offered for sale on a marketplace, with its picture, description, price and stock count. One merchant may run hundreds of them.. Small software writers build stock tracking tools that read Setu Bazaar listings. Neighbourhood carton makers began cutting boxes to the parcel sizes Setu Bazaar despatches in. Setu Bazaar chose none of them and pays every one of them Rs 0/-. The third group is the ecosystem.

Why would anyone add value to a firm that pays them nothing?

The answer decides whether any of the rest is believable, so it is worth sitting with rather than accepting. Nobody works for free. If a trainer spends a Saturday teaching twelve shopkeepers how to build a listing, that trainer is not doing Setu Bazaar a favour, and no amount of goodwill would keep it going for a year. Something has to be paying the trainer, and the something is not Setu Bazaar.

Work it through with figures. Assume, only so the size is visible, that the trainer charges Rs 1,500/- a head and teaches twenty shopkeepers a month. The fees come to Rs 30,000/- a month and Rs 3,60,000/- a year, all of it collected from the shopkeepers. Now ask what happens to the trainer when Setu Bazaar grows. More shopkeepers want to list, so more of them need teaching, so the trainer has more people to charge. The trainer's income rises with Setu Bazaar's spread and no rupee ever moves between the two.

Aligned interest does the work a contract would otherwise have to do, and so an ecosystem costs almost nothing and cannot be commanded. Both halves of that sentence come from the same fact. The trainer's own customers are paying, so Setu Bazaar does not have to negotiate with the trainer, monitor the trainer or budget for the trainer. And because there is nothing to enforce and nothing to withdraw, Setu Bazaar cannot tell the trainer what to teach, cannot require a standard of teaching, and cannot stop the trainer switching to a rival marketplace next month.

The same shape turns up everywhere once it is looked for. Marco Iansiti and Roy Levien set it out at length in The Keystone Advantage, published in 2004, where the question they keep returning to is what each participant puts in and what each draws back out. The point for now is smaller. Whether an ecosystem will hold together is not settled by asking whether the participants like the firm. The answer is settled by what each participant is earning, and from whom.

How is an ecosystem different from a supply chain?

Most of the trouble people get into with this word comes from one habit: treating anyone the firm works closely with as part of its ecosystem. The delivery partner is close. The gateway is close. The mill that supplies paper is very close indeed, and a stationery manufacturer talks to it every week. None of them is an ecosystem, and closeness is exactly what misleads.

The test is control and payment, not closeness, and both tests have to fail before the word applies. Ask two questions about any participant. Did the firm choose it, and can the firm tell it what to do? Does the firm pay it? A contracted carrier answers yes twice. The carrier was picked from three quotes, instructed on routes and service levels, and paid on an invoice each month, and if it disappoints, it can be replaced by tenderA process in which a buyer publishes what it wants and invites sellers to quote, then picks one. It only works where the thing being bought can be specified in writing.. Such a relationship is a supply chain, and who a business depends on in that way is set out under The Value Network: Who a Business Depends On.

A merchant photographing a saree answers no twice. Setu Bazaar did not select that merchant from a shortlist, does not tell the merchant when or how to shoot, and pays nothing. The merchant does it because a listing with a good photograph sells, and the merchant wants the sale. Two failures, so the word applies.

Two tests with two answers each make four cells, not two, and it is worth seeing all four before the word is used in anger. Three of Setu Bazaar's outside participants are directed and paid, and those three are the supply chain. Five are neither, and those five are the ecosystem. One sits in a third cell: merchants who accept Setu Bazaar's despatch deadline in order to keep a listing visible are directed by Setu Bazaar and paid nothing by it. No money moves, so those merchants are not a supply chain. They are complying rather than choosing, so they are not an ecosystem either. The fourth cell, participants paid without being directed, is empty for Setu Bazaar. A referral fee paid to anyone who sends a buyer would sit there.

An empty cell is a finding, not a gap. The empty cell shows that Setu Bazaar has not yet chosen to buy behaviour it cannot specify, and that is a real fact about how the marketplace is run.

Is a platform the same thing as an ecosystem?

No, and the two words get swapped so often that it is worth being blunt about the relationship. A platform is a business that sets the terms on which two other groups meet: Setu Bazaar decides what a listing must contain, what a merchant may charge for delivery, when money reaches a seller, and what happens when a buyer complains. Setu Bazaar does not buy the goods and does not take title to them. Jean-Charles Rochet and Jean Tirole gave the formal treatment of markets with two such sides in a 2003 paper on platform competition, and the full working of one, including why it is so hard to start and why growth on one side is not good news for everyone on it, is set out under Platform Businesses: Why Two-Sided Markets Behave Differently.

Not every ecosystem is a platform, and not every platform manages to build one. Anjani Stationers is nobody's platform. The company manufactures notebooks and registers and sells them to a few dozen business buyers, and it still has a shop assistant somewhere who finds its ruling the easiest to sell and pushes it without being asked. The assistant is an ecosystem of one, on a business with no two-sided market anywhere in it. Run the other way: a marketplace can set every term, take a cut of every order, and still have nobody outside it doing anything unpaid. Merchants photograph nothing, no buyer reviews anything and no trainer has appeared. The terms exist; the third box is empty. Which word fits depends on which question is being asked. Platform is a question about structure. Ecosystem is a question about where value comes from.

What happens when the sort is run on two invented companies?

The exercise, done twice, and the second run is the one that matters. Setu Bazaar is already sorted: twelve named participants, three inside the edge, three bought across it, one bound without payment, five neither directed nor paid. Its gross merchandise valueThe total value of goods sold through a marketplace in a period, counted before the marketplace takes anything out of it. It is what passes through, not what the marketplace earns. is Rs 500 crore in a year and its revenue is Rs 20 crore, from fifty thousand buyers who each put roughly Rs 1,00,000/- of goods through it and each leave Rs 4,000/- of revenue behind.

Now Anjani Stationers Private Limited, an invented manufacturer. Revenue of Rs 2,70,00,000/-, earnings before interest and tax (EBIT) of Rs 41,50,000/-, profit after tax of Rs 30,00,000/-, and an operating margin of 15.37 per cent. The company manufactures and sells to a few dozen business buyers. Inside its edge: machine operators, a despatch clerk, two salespeople on the road. Across the edge and paid: the mill that supplies paper reels, the transporter, the ink and glue supplier, the machine maker's service engineer. Bound and unpaid: dealers who have to take a minimum order each quarter to keep the trade priceThe lower price a manufacturer charges a dealer rather than an end customer, usually conditional on order size or on the dealer holding stock.. And the third box holds one entry: a counter assistant at a dealer's shop who reaches for the Anjani register first because it is easy to sell.

A firm can have almost no ecosystem at all and still be a perfectly sound business. Anjani Stationers earns EBIT of Rs 41,50,000/- on revenue of Rs 2,70,00,000/- with a third box holding one person it has never met. If that assistant moved to another job tomorrow the box would be empty and the accounts would not move. Setu Bazaar's third box holds five and would be visibly poorer without them. Both facts are true, neither is a verdict, and which is the better business turns on questions taken up elsewhere.

What does a firm give up to sit inside one?

An ecosystem so far sounds like something for nothing, and that is the reading to kill before it settles. An ecosystem costs the firm something real, and the cost is paid in a currency that never appears in the accounts.

A firm inside an ecosystem has traded control for reach, and the trade is real rather than free. Setu Bazaar cannot instruct a merchant to photograph anything. Setu Bazaar cannot insist a photograph is good, or evenly lit, or shows the actual item. Setu Bazaar cannot stop a trainer teaching a rival marketplace on the same Saturday. The marketplace cannot make any of it continue, and cannot make it stop. The reason is exactly the reason it is cheap: there is no payment, so there is nothing to withhold, and no agreement, so there is nothing to enforce.

A size on the reach keeps the trade from being abstract. Assume, only to make the scale visible, that Setu Bazaar would otherwise pay Rs 40/- for a photograph and that merchants supply 5,00,000 photographs in a year. The merchants supply Rs 2 crore of photography Setu Bazaar does not buy, against revenue of Rs 20 crore, so a tenth of its revenue would be needed to replace one thing the ecosystem does. Both of those inputs are assumed and both are printed, so other figures can be put through in their place.

Now feel the other side of it. Because Setu Bazaar buys none of those photographs, it also cannot guarantee a single one, and a buyer who receives a saree that looks nothing like its picture will blame Setu Bazaar rather than the merchant. The complaint lands inside the edge even though the photograph was taken outside it. The trade has an ordinary shape. The benefit arrives from outside and cannot be directed. The consequences arrive at the edge and cannot be refused. A household knows this pattern well. Neighbours who watch the street make a lane safer than any paid guard could, and the same neighbours cannot be told when to look, cannot be scheduled and will not be there the week they all travel.

What does calling something an ecosystem not establish?

The word is doing one job and it is a narrow one. The word says where value comes from. The word does not say how much, it does not say for how long, and above all it does not say who ends up with it.

Ecosystem describes where value comes from and says nothing about who keeps it. Take Setu Bazaar's five participants again. Merchants photograph goods, and the better photograph makes the merchant's own listing sell, so a share of that value stays with the merchant. Buyers write reviews, and the reviews make other buyers more confident, so a share reaches buyers who never wrote one. Trainers teach, and the shopkeepers they teach get better at selling. How much of any of it settles with Setu Bazaar is a completely separate question. Where the money along a chain actually sits, and why the stage with the most flow is often not the stage with the most profit, is set out under The Profit Pool: Where the Money in an Industry Actually Sits.

Two more things the word does not establish, and both catch careful readers. The word does not establish size: an ecosystem of five participants might contribute less than a single hired carrier does, and nothing in the sort settles which. And it does not establish durability. The five participants are held in place by their own interest, and that interest holds them exactly as long as it lasts and not one day longer. A rival marketplace with a better arrangement for merchants can move the photographs, the trainers and the tool writers inside a year, and Setu Bazaar will have no contract to point at, having never had one. The absence of a contract is the same fact that made the arrangement cheap, read from the other end.

What does an analyst ask first?

The whole sort collapses into one working question, and it is the question to carry into any set of statements or any management call.

Ask who benefits from this firm's success without being paid by it. No other question finds the ecosystem. The question works because it is the ecosystem's definition turned into an instrument. Anyone who gets richer as the firm grows, and whose name does not appear in the firm's cost lines, is standing in the third box. Run on Setu Bazaar, it finds the trainers, the tool writers, the carton makers who retooled, the merchants who invested in photographs and the buyers whose reviews make their own next purchase safer. Run on Anjani Stationers, it finds one counter assistant.

Then ask the follow-up, the place where the analysis actually earns its keep. Does any of that value come back to the firm, and through what? For Setu Bazaar the honest chain is: better photographs make listings convert, more conversions raise the goods passing through, and Setu Bazaar keeps 4.00 per cent of what passes through. The chain is a real route, and a real route is what makes the ecosystem worth attention rather than worth admiring. Where a chain like that cannot be traced, the ecosystem may be perfectly genuine and still make no difference to the firm at all.

Three habits keep this from becoming decoration. First, count. Five participants and one participant are different situations, and a company that describes an ecosystem without naming who is in it has described a feeling. Second, check the money. If the firm is paying, it is a supply chain, whatever the annual report calls it. Third, ask what would have to be true for the participants to leave. The answer names the fragility that no contract is covering.