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The success of platform companies like Airbnb, Amazon, and Netflix has led to envy bordering on despair for their competitors. When we asked one successful online retailer “How do you compete with Amazon?” the response was “You don’t.” Publicly, CEOs talk about digital transformation, but privately, they wonder if their efforts will be enough.

Companies are right to be worried. Our research shows that companies with platform- and network-based business models are exponentially better at creating value. They grow faster, make more money, and are more valued than companies organized around products and services.

Building a successful platform business is hard enough when you have an original idea, ample capital, no core business to cannibalize, and a team of top talent. (Just ask the executives at Uber, Twitter, Fitbit, and Snapchat.) So what’s a legacy company to do? You might think that you have to turn yourself into a Silicon Valley startup and reinvent your business model.

The good news is that you can harness the power of platforms and network effects without turning yourself completely inside out. The business press tends to focus on “pure-play” platforms like Facebook, eBay, and PayPal. But platforms and networks can be developed in many different ways.

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Think of platforms and networks in our digital age as the equivalent of electricity and motors in the industrial age. Some companies were in the pure-play electricity and motor business, like General Electric and General Motors. But most successful companies used electricity and motors to reinvent their existing businesses, whether in manufacturing, transportation, or construction. It would have been foolhardy for a manufacturer in the 1930s to create a separate division to pursue an “electrical business.” And yet it is the mistake many companies have already made by separating their “digital business,” and they are susceptible to making it again with platforms and networks.

The reason companies make this mistake is because they confuse thinking and doing. Platforms and networks are a mental model as much as a business model. The traditional way of thinking about value creation is linear and incremental. A production process turns inputs into outputs and distributes them through a tightly controlled supply chain. Value is in the products and services themselves. The new way of thinking about value creation is networked and exponential. A platform connects providers and users in a multisided market. The value is not in the items being produced one at a time but in the connections being made many-at-once. In the language of networks, the value of the platform provider is not in creating the nodes (whether people, things, or data) but in fostering the connections between the nodes.

As an example, hotel chains like Marriott or Hilton create value chains that deliver rooms and related services to their customers. In contrast, Airbnb creates a network that connects hosts and guests. Retailers like Walmart and Macy’s manage a supply chain, buying and reselling their own inventory. By contrast, Alibaba and Amazon create connections between buyers and sellers.

Note that people often get hung up on definitions of “platform” these days. A platform can be a business platform (a multisided market), a software platform (a cloud-based subscription service), or an engagement platform, (a user-generated community). What defines a platform is the ability to generate a network effect.

Einstein’s famous formula of E=MC2 can be adapted for our purposes. Think of E as Enterprise Value. M is Mass, in this case all the things, people, and assets of your ecosystem. C2 is the exponential effect of Connectivity and Co-creation. In a traditional business, there is little connectivity or co-creation, so the enterprise value is equal to the “mass” of the company — its human resources, financial assets, intellectual property, and physical goods. By adding connections and co-creation, we multiply the ability of these assets to create value.

To put this new way of thinking into practice, we have found it helpful to think about networking different types of capital. In our E=MC2 equation, you start with your M and then add the C2 to generate more E.

Every organization has five types of capital: human, financial, intellectual, physical, and relational. Let’s see what happens when we connect them rather than manage them — that is, focus on the links rather than the nodes.

  • Human capital. We normally think of people as something to be managed. After all, we call the department human resources. Organizations create value by managing people (inputs) to generate products and services (outputs). But consider the organization itself as a platform, connecting people who have ideas, skills, and work with the people who need them. Companies like GE are using crowdsourcing platforms that engage people from inside and outside the company. Others, like Morning Star and Zappos, are taking a more networked approach to the way the company is managed and governed. Where traditional companies try to increase productivity by focusing on M, these companies work on increasing connectivity (C2).
  • Intellectual capital. For most companies intellectual property is something that sits on their balance sheet. Patents, trademarks, brands, data, and software (IP) are proprietary assets creating differentiation. But what if the value is not in the intellectual capital itself but in the connectivity of that IP? For example, open APIs are protocols for data exchange that enable the sharing of software and data among customers, suppliers, and partners. Software connectivity and data exchange are at the heart of platform companies like Salesforce and Google. But traditional brands like Best Buy, Citi, Walgreens and Kaiser Permanente are also opening up access to create data-driven ecosystems. They recognize that the way to create value (E) is by creating not scarcity and exclusivity (M) but connectivity and utility (C2).
  • Physical capital. We normally think of the value of an asset as originating in what someone will pay for it and how they will use it. But in a digital world, physical goods become sentient and social. They are able to generate value in how they work together. Consider how Nest is networking its thermostats, smoke alarms, and cameras to create home security solutions, or how Caterpillar and GE are each networking their equipment and engines to save millions in maintenance costs. The internet of things is not just about making products smarter; it’s about connecting them to each other. Every company should be thinking about how its products and assets could become a Social Network of Things.
  • Financial capital. You might think that money is money. But we are moving toward more-networked forms of currency. Some of these are digital currencies like bitcoin, which is built on distributed models of verification and payment through the blockchain. Some are branded currencies, like the points in a loyalty program or the cash in an iTunes account or Starbucks mobile app. Even funding sources can be networked, as in the case of Kickstarter and other crowdfunding models. Money itself is becoming more intelligent and connected.
  • Relational capital. To achieve loyalty, most companies focus on managing their customer relationships. After all, there is a multibillion-dollar industry focused on customer relationship management. But a networking mindset goes beyond the relationships you have with your customers and looks for opportunities to connect them with each other. This could be directly, as Sephora does with its online communities using beauty tips as currencies. Or it could be indirectly, as Opower does in giving people benchmarking data on energy usage to foster conservation and efficiency. The value of your customers is more than what they do for you (E=M) — it’s what they do for each other (E=MC2).

Different companies can pursue quite different platform strategies based on what kinds of capital they choose to network together. Consider the different paths of Waze and Google Maps as mobile apps. Both have the feature of displaying traffic congestion. But one does so by networking physical and intellectual capital, and the other does it by networking human and relational capital. Google Maps uses anonymized data from the GPS of drivers’ mobile devices, relying on APIs and algorithms to generate traffic conditions in real time. Waze, on the other hand, uses members of the Waze community to report road conditions, relying on reciprocity and appreciation as a social currency.

There are five steps to incorporating these network effects into your business (which we call PIVOT):

  1. Purpose: Define the shared objective that everyone in your community or ecosystem will contribute to and benefit from. For Google Maps and Waze, this is saving time and getting where you want to go, or as Waze says, “Outsmarting traffic together.”
  2. Inventory: Identify the potential types of capital that might be networked together. Google Maps went in the direction of networking people’s phones, whereas Waze chose to network the people themselves.
  3. Validate: Test the ability to create value for the network through iteration and co-creation. The director of growth for Waze has described how the company went through many experiments to find the right engagement model.
  4. Operate: Deploy the platform to foster connections and the exchange of value at scale. This might involve building your own platform, or acquiring or becoming part of someone else’s. Both ZipDash, the creator of GPS traffic reporting, and Waze ended up joining Google to achieve more scale.
  5. Track: Create new KPIs to measure the success and growth of the network. Most KPIs are focused on E and M. You want KPIs that measure the network effect, or C2. In the beginning, Waze didn’t care about how many people signed up. It wanted to know how intensely people were using the service. Since it was networking human and relational capital, its KPIs were about participation and engagement. By contrast, ZipDash was networking devices, so its KPIs were focused on data-oriented measures like latency and coverage.

Everyone on the leadership team has a role to play in making this pivot. The CHRO can be working on networking employees and locations; the CMO on networking customers and partners; the CFO on networking funding and payments; the CIO on software and data; and the COO on products and services. The job of the CEO should be changing the KPIs and shifting the capital allocations to reinforce a culture of collaboration and realign the business for exponential growth.

As you embark on your network journey, keep in mind that the place to start is with your mental model. Value in a network is about what you connect, not what you make. Change how you think, and you will naturally change what you do. Then change what you measure to align incentives and track your progress.

Original Article