NANT Competing in two worlds: the marketplace and the marketspace Reprinted from the New ways to create digital assets Beware: many of the old business axioms no longer apply Exploiting the virtual value chain Jeffrey F Rayport John J Sviokla E VERY BUSINESS TODAY competes in two worlds: a physical world of resources that managers can see and touch, and a virtual world made of information. The latter has given rise to the world of electronic commerce. a new locus of value creation. We call this new information world the marketspace to distinguish it from the physical world of the marketplace. A few examples illustrate the distinction. When consumers use answering machines to store their phone messages, they are using objects made and sold in the physical world, but when they purchase electronic answering services from their local phone companies, they are utilizing the marketspace-a virtual realm where products and services exist as digital information and can be delivered through information-based channels Banks provide services to customers at branch offices in the marketplace as well as electronic online services to customers in the marketspace; airlines sell passenger tickets in both the"place"and the"space"; and fast-food outlets take orders over the counter at restaurants and increasingly through touch screens connected to computers Jeffrey Rayport is an assistant professor and John Sviokla is an associate professor at the Harvard Business School. This article is reprinted by special permission from the November-December 1995 issue of the Harvard Business Review. Copyright o 1995 the President and Fellows of Harvard College. All rights reserved. THE McKINSEY QUARTERLY 1996 NUMBER I 21
THE McKINSEY QUARTERLY 1996 NUMBER 1 21 EVERY BUSINESS TODAY competes in two worlds: a physical world of resources that managers can see and touch, and a virtual world made of information. The latter has given rise to the world of electronic commerce, a new locus of value creation. We call this new information world the marketspace to distinguish it from the physical world of the marketplace. A few examples illustrate the distinction. When consumers use answering machines to store their phone messages, they are using objects made and sold in the physical world, but when they purchase electronic answering services from their local phone companies, they are utilizing the marketspace – a virtual realm where products and services exist as digital information and can be delivered through information-based channels. Banks provide services to customers at branch oƒfices in the marketplace as well as electronic online services to customers in the marketspace; airlines sell passenger tickets in both the “place” and the “space”; and fast-food outlets take orders over the counter at restaurants and increasingly through touch screens connected to computers. Jeƒfrey Rayport is an assistant professor and John Sviokla is an associate professor at the Harvard Business School. This article is reprinted by special permission from the November–December 1995 issue of the Harvard Business Review. Copyright © 1995 the President and Fellows of Harvard College. All rights reserved. Jeƒfrey F. Rayport • John J. Sviokla Exploiting the virtual value chain Competing in two worlds: the marketplace and the marketspace New ways to create digital assets Beware: many of the old business axioms no longer apply Reprinted from the Harvard Business Review
EXPLOITING THE VIRTUAL VALUE CHAIN Executives must pay attention to the ways in which their companies create value in the physical and virtual worlds alike. But the processes for creating value are not the same in both. By understanding the differences and the interplay between the value-adding processes of the physical and informa- tion worlds, senior managers can see more clearly and comprehensively the strategic issues facing their organizations Managing two interacting alue-adding processes in the two mutually dependent realms poses new conceptual and tactical challenges. Those who understand how to master both can create and extract value in the most efficient and effective manner The value chain Academics, consultants, and managers have long described the stages in the process of creating value in the physical world as links in a"value chain. The value chain is a model that describes a series of value-adding activities connecting a company's supply side(raw materials, inbound logistics, and production processes)with its demand side(outbound logistics, marketing, and sales). By analyzing the stages of a value The value-adding processes chain, managers have been able to redesign that companies must employ r internal and external processes to are unique to the virtual improve efficiency and effectiveness world of information The value chain model treats information as a supporting element in the value-adding process, not as a source of value in itself. Managers often use information that they capture on inventory, production, or logistics to help monitor or control those processes, for instance, but they rarely use information itself to create new value for the customer. However, Federal Express recently did just that by allowing customers to track packages through the company World Wide Web site on the Internet. Now customers can locate a package in transit by connecting online to the Fed Ex site and entering the airbill number. After the package has been delivered, they can even find out who signed for it. Although FedEx provides this service for free, in doing so it has created added value for the customer-and thus increased loyalty -in a fiercely competitive market. To create value with information, managers must look to the marketspace Ithough the value chain of the space can mirror that of the place-buyers and sellers can transfer funds over electronic networks just as they might exchange cold, hard cash-the value-adding processes that companies must employ to turn raw information into new marketspace services and products are unique to the information world. In other words, the alue-adding steps are virtual in that they are performed through and with information 22 THE McKINSEY QUARTERLY 1996 NUMBER I
Executives must pay attention to the ways in which their companies create value in the physical and virtual worlds alike. But the processes for creating value are not the same in both. By understanding the diƒferences and the interplay between the value-adding processes of the physical and information worlds, senior managers can see more clearly and comprehensively the strategic issues facing their organizations. Managing two interacting value-adding processes in the two mutually dependent realms poses new conceptual and tactical challenges. Those who understand how to master both can create and extract value in the most eƒficient and eƒfective manner. The value chain Academics, consultants, and managers have long described the stages in the process of creating value in the physical world as links in a “value chain.” The value chain is a model that describes a series of value-adding activities connecting a company’s supply side (raw materials, inbound logistics, and production processes) with its demand side (outbound logistics, marketing, and sales). By analyzing the stages of a value chain, managers have been able to redesign their internal and external processes to improve eƒficiency and eƒfectiveness. The value chain model treats information as a supporting element in the value-adding process, not as a source of value in itself. Managers oƒten use information that they capture on inventory, production, or logistics to help monitor or control those processes, for instance, but they rarely use information itself to create new value for the customer. However, Federal Express recently did just that by allowing customers to track packages through the company’s World Wide Web site on the Internet. Now customers can locate a package in transit by connecting online to the FedEx site and entering the airbill number. Aƒter the package has been delivered, they can even find out who signed for it. Although FedEx provides this service for free, in doing so it has created added value for the customer – and thus increased loyalty – in a fiercely competitive market. To create value with information, managers must look to the marketspace. Although the value chain of the space can mirror that of the place – buyers and sellers can transfer funds over electronic networks just as they might exchange cold, hard cash – the value-adding processes that companies must employ to turn raw information into new marketspace services and products are unique to the information world. In other words, the value-adding steps are virtual in that they are performed through and with information. EXPLOITING THE VIRTUAL VALUE CHAIN 22 THE McKINSEY QUARTERLY 1996 NUMBER 1 The value-adding processes that companies must employ are unique to the virtual world of information
EXPLOITING THE VIRTUAL VALUE CHAIN Creating value in any stage of a virtual value chain involves a sequence of five activities: gathering, organizing, selecting, synthesizing, and distributing information. Just as a company takes raw material and refines it into some thing useful -as in the sequence of tasks involved in assembling an auto- mobile on a production line- so a manager today collects raw information and adds value through these steps Adapting to a virtual world An examination of Geffen Records. a unit of MCAs music division shows how information can be used to create value. The traditional product of a record label is a package of prerecorded music captured on an audio- cassette or compact disc. The product is the culmination of a set of value adding processes that take place in the physical world. These processes include discovering new musicians, screening them for marketability, recording their work in a studio, editing and selecting their music, creating master tapes, producing CDs or cassettes, and finally packaging, promoting, and distributing the product. Increasingly, new competitors for Geffen's business are emerging in the marketspace. These entrants are viable because of the new economics of doing business in the world of information. Groups such as the Internet Underground Music Archive(IUMA), for example, are posting digital audio tracks from unknown artists on the network, potentially subverting the role that record labels play. Today's technology allows musicians to record and edit material inexpensively themselves, and to distribute and promote it over networks such as the world wide Web or commercial online services. It also allows them to test consumers reactions to their The Web page is also an music, build an audience for their recorded information mirror of an performances, and even distribute their activity that has traditionally products entirely in the marketspace. The occurred in the physical world point here is simple: bringing music to market can sometimes be done more quickly, more effectively, and less expensively in the marketspace. Hence the challenge for Geffen. The label has a site on the world wide Web devoted to its bands and uses it to distribute digital audio and video samples and to provide information about the bands' tours The Web page has become both Geffen's showroom in the marketspace and a potential new retail channel. It is also an information mirror of an activity that has traditionally occurred in the physical world-a stage in a virtual value chain that parallels a stage in a physical value chain. In addition to using its own Web page, Geffen could search for new talent IUMA's home site rather than audition bands in a studio, or edit and modify music on a computer rather than record take after take with a band THE McKINSEY QUARTERLY 1996 NUMBER 1 23
Creating value in any stage of a virtual value chain involves a sequence of five activities: gathering, organizing, selecting, synthesizing, and distributing information. Just as a company takes raw material and refines it into something useful – as in the sequence of tasks involved in assembling an automobile on a production line – so a manager today collects raw information and adds value through these steps. Adapting to a virtual world An examination of Geƒfen Records, a unit of MCA’s music division, shows how information can be used to create value. The traditional product of a record label is a package of prerecorded music captured on an audiocassette or compact disc. The product is the culmination of a set of valueadding processes that take place in the physical world. These processes include discovering new musicians, screening them for marketability, recording their work in a studio, editing and selecting their music, creating master tapes, producing CDs or cassettes, and finally packaging, promoting, and distributing the product. Increasingly, new competitors for Geƒfen’s business are emerging in the marketspace. These entrants are viable because of the new economics of doing business in the world of information. Groups such as the Internet Underground Music Archive (IUMA), for example, are posting digital audio tracks from unknown artists on the network, potentially subverting the role that record labels play. Today’s technology allows musicians to record and edit material inexpensively themselves, and to distribute and promote it over networks such as the World Wide Web or commercial online services. It also allows them to test consumers’ reactions to their music, build an audience for their recorded performances, and even distribute their products entirely in the marketspace. The point here is simple: bringing music to market can sometimes be done more quickly, more eƒfectively, and less expensively in the marketspace. Hence the challenge for Geƒfen. The label has a site on the World Wide Web devoted to its bands and uses it to distribute digital audio and video samples and to provide information about the bands’ tours. The Web page has become both Geƒfen’s showroom in the marketspace and a potential new retail channel. It is also an information mirror of an activity that has traditionally occurred in the physical world – a stage in a virtual value chain that parallels a stage in a physical value chain. In addition to using its own Web page, Geƒfen could search for new talent at IUMA’s home site rather than audition bands in a studio, or edit and modify music on a computer rather than record take aƒter take with a band EXPLOITING THE VIRTUAL VALUE CHAIN THE McKINSEY QUARTERLY 1996 NUMBER 1 23 The Web page is also an information mirror of an activity that has traditionally occurred in the physical world
EXPLOITING THE VIRTUAL VALUE CHAIN to create one suitable version for the mastertape. Each activity is a stage in a virtual value chain that occurs through and with information and mirrors a Truly to exploit the virtual value chain, however, Geffen's managers might go further by applying the generic value-adding steps of the marketspace to the information the company collects at every stage of the physical chain, Companies must oversee a They might, for example, utilize the digital physical value chain, but they information captured during a bands must also build and exploit practice sessions by inviting fans to"sit in a virtual value chain the studio"on the Internet. They might also allow fans to listen as engineers edit the material, or let them electronically down load interviews with band members in advance of wider publication or distribution. In the physical value chain, information collected in the studio or during editing has value to the extent that it enables Geffen to produce and sell CDs more efficiently; by contrast in the virtual world, it is a potential source of new revenue. Moreover, that information presents opportunities to develop new relationships with customers at very low cost for instance, a customer who would not be interested in a new compact disc by the rolling Stones might nevertheless pay to sit in on a chat session with them in the internets voodoo lounge Like most companies, Geffen must play in both the place and the space. The company's managers must continue to oversee a physical value chain making and selling CDs- but they must also build and exploit a We have studied scores of companies from a variety of industries attempting to do business in both the place and the space and have found that organizations making money in the information realm successfully exploit both of their value chains. Instead of managing one series of value dding processes, they are actually managing two. The economic logic of the two chains is different: conventional understanding of the economies of Building the virtual value chain abound Physical value chain processes Marketing Information]capture Ahen companies integrate the information they underlay of the and marketing- they construct an information 24 THE McKINSEY QUARTERLY 1996 NUMBER I
to create one suitable version for the mastertape. Each activity is a stage in a virtual value chain that occurs through and with information and mirrors a stage in the physical world. Truly to exploit the virtual value chain, however, Geƒfen’s managers might go further by applying the generic value-adding steps of the marketspace to the information the company collects at every stage of the physical chain, thereby creating new value for customers. They might, for example, utilize the digital information captured during a band’s practice sessions by inviting fans to “sit in the studio” on the Internet. They might also allow fans to listen as engineers edit the material, or let them electronically download interviews with band members in advance of wider publication or distribution. In the physical value chain, information collected in the studio or during editing has value to the extent that it enables Geƒfen to produce and sell CDs more eƒficiently; by contrast in the virtual world, it is a potential source of new revenue. Moreover, that information presents opportunities to develop new relationships with customers at very low cost: for instance, a customer who would not be interested in a new compact disc by the Rolling Stones might nevertheless pay to sit in on a chat session with them in the Internet’s Voodoo Lounge. Like most companies, Geƒfen must play in both the place and the space. The company’s managers must continue to oversee a physical value chain – making and selling CDs – but they must also build and exploit a virtual value chain. We have studied scores of companies from a variety of industries attempting to do business in both the place and the space and have found that organizations making money in the information realm successfully exploit both of their value chains. Instead of managing one series of valueadding processes, they are actually managing two. The economic logic of the two chains is diƒferent: conventional understanding of the economies of EXPLOITING THE VIRTUAL VALUE CHAIN 24 THE McKINSEY QUARTERLY 1996 NUMBER 1 Companies must oversee a physical value chain, but they must also build and exploit a virtual value chain Building the virtual value chain Exhibit 1 Inbound logistics Production processes Outbound logistics Marketing Sales Physical value chain Virtual value chain Information capture When companies integrate the information they capture during stages of the value chain – from inbound logistics and production through sales and marketing – they construct an information underlay of the business. This integrated information provides managers with the ability to “see” their value chains from end to end
EXPLOITING THE VIRTUAL VALUE CHAIN scale and scope does not apply to the virtual value chain(vvc)in the same way as it does to the physical value chain(Pvc). Moreover, the two chains must be managed distinctly but also in concert Companies tend to adopt value-adding information processes in three stages. In the first, visibility, companies acquire an ability to "see"physical operations more effectively through information. At this stage, managers use large-scale information technology systems to coordinate activities in their physical value chains, in the process laying the foundation for a virtual value chain. In the second stage, mirroring capability, companies substitute virtual activities for physical ones; they begin to create a parallel value chain in the marketspace. Finally, businesses use information to establish new customer relationships. At this third stage, managers draw on the flow of information in their virtual value chain to deliver value to customers in new ways. In effect, they apply the generic value-adding activities to their virtual value chain and thereby exploit what we call the value matrix As companies move into the information world to perform value-addin steps, the potential for top-line growth increases. Each of the three stages represents a considerable opportunity for managers. Visibility During the past 30 years, many companies have invested in technology ystems to enable managers to coordinate, measure, and sometimes control business processes. The information about steps in the value chain collected by these systems has helped managers to plan, execute, and evaluate results with greater precision and speed. In other words, information technology has allowed managers to see their operations more Conventional understanding of the economies of scale effectively through the information world. In and scope does not apply recent years, managers have been able to the virtual value chain gain access to the information generated in the course of traditional operating activities, and that information helps them see their physical value chains as an integrated system rather than as a set of discrete though related activities In this way, they can gain new insights into managing the value chain as a whole instead of as a collection of parts. Companies such as Fed Ex, Wal-Mart, and Frito-Lay have transformed this kind of visibility into competitive advantage. The successful use of world-class information systems by each of these companies is now common know ledge, but consider one example- Frito-Lay -from the perspective of the marketspace. Frito's achievement with its widely publicized"information THE McKINSEY QUARTERLY 1996 NUMBER 1 25
scale and scope does not apply to the virtual value chain (VVC) in the same way as it does to the physical value chain (PVC). Moreover, the two chains must be managed distinctly but also in concert. Companies tend to adopt value-adding information processes in three stages. In the first, visibility, companies acquire an ability to “see” physical operations more eƒfectively through information. At this stage, managers use large-scale information technology systems to coordinate activities in their physical value chains, in the process laying the foundation for a virtual value chain. In the second stage, mirroring capability, companies substitute virtual activities for physical ones; they begin to create a parallel value chain in the marketspace. Finally, businesses use information to establish new customer relationships. At this third stage, managers draw on the flow of information in their virtual value chain to deliver value to customers in new ways. In eƒfect, they apply the generic value-adding activities to their virtual value chain and thereby exploit what we call the value matrix. As companies move into the information world to perform value-adding steps, the potential for top-line growth increases. Each of the three stages represents a considerable opportunity for managers. Visibility During the past 30 years, many companies have invested in technology systems to enable managers to coordinate, measure, and sometimes control business processes. The information about steps in the value chain collected by these systems has helped managers to plan, execute, and evaluate results with greater precision and speed. In other words, information technology has allowed managers to see their operations more eƒfectively through the information world. In recent years, managers have been able to gain access to the information generated in the course of traditional operating activities, and that information helps them see their physical value chains as an integrated system rather than as a set of discrete though related activities. In this way, they can gain new insights into managing the value chain as a whole instead of as a collection of parts. Companies such as FedEx, Wal-Mart, and Frito-Lay have transformed this kind of visibility into competitive advantage. The successful use of world-class information systems by each of these companies is now common knowledge, but consider one example – Frito-Lay – from the perspective of the marketspace. Frito’s achievement with its widely publicized “information EXPLOITING THE VIRTUAL VALUE CHAIN THE McKINSEY QUARTERLY 1996 NUMBER 1 25 Conventional understanding of the economies of scale and scope does not apply to the virtual value chain
EXPLOITING THE VIRTUAL VALUE CHAIN revolution"initiative illustrates the necessary first steps companies mus take if they are to establish and then exploit their virtual value chains. Underlying the manufacture and distribution of a variety of Frito-brand snack foods is an efficient information system that gives managers the bility to visualize nearly every element of the company's value chain as part of an integrated whole. It acts as a central nervous system within the business that integrates marketing, sales, manufacturing, logistics, and finance; it also provides managers with information on suppliers, customers, and competitors Frito's employees in the field collect information on the sales of products daily, store by store across the United States, and feed it electronically to the company. They also collect information Companies begin to create about the sales and promotion of competing a virtual value chain that products, or about new products launched parallels but improves on by competitors in selected locations. By the physical value chain combining this field data with information from each stage of the value chain, Fritos managers can better determine levels of inbound supplies of raw materials, allocate manufacturing activity across available production capacity, and plan truck routing for the most efficient coverage of market areas. The company's ability to target local demand patterns with just the right sales promotion means that it can continuously optimise margin in the face of inventory risk In short, Frito can use information to see and react to activities along its physical value chain. The company executes actions in the marketplace while it monitors and coordinates these actions in the marketspace. Mirroring capability Once companies have established the necessary infrastructure for visibility, they can do more than just monitor value-adding steps. They can begin to manage operations or even to implement value-adding steps in the marketspace- more quickly, more effectively, with more flexibility, and at lower cost. In other words, managers can begin to ask: What are we doing now in the place, and what could we do more efficiently or more effectively in the space? What value-adding steps currently performed in the physical value chain might be shifted to the mirror world of the virtual value chain? When companies move activities from the place to the space, they begin to create a virtual value chain that parallels but improves on the physical value chain. Executives at Ford Motor Company engaged in such work during the past decade as the company aggressively adopted videoconferencing and 26 THE McKINSEY QUARTERLY 1996 NUMBER I
revolution” initiative illustrates the necessary first steps companies must take if they are to establish and then exploit their virtual value chains. Underlying the manufacture and distribution of a variety of Frito-brand snack foods is an eƒficient information system that gives managers the ability to visualize nearly every element of the company’s value chain as part of an integrated whole. It acts as a central nervous system within the business that integrates marketing, sales, manufacturing, logistics, and finance; it also provides managers with information on suppliers, customers, and competitors. Frito’s employees in the field collect information on the sales of products daily, store by store across the United States, and feed it electronically to the company. They also collect information about the sales and promotion of competing products, or about new products launched by competitors in selected locations. By combining this field data with information from each stage of the value chain, Frito’s managers can better determine levels of inbound supplies of raw materials, allocate manufacturing activity across available production capacity, and plan truck routing for the most eƒficient coverage of market areas. The company’s ability to target local demand patterns with just the right sales promotion means that it can continuously optimise margin in the face of inventory risk. In short, Frito can use information to see and react to activities along its physical value chain. The company executes actions in the marketplace while it monitors and coordinates these actions in the marketspace. Mirroring capability Once companies have established the necessary infrastructure for visibility, they can do more than just monitor value-adding steps. They can begin to manage operations or even to implement value-adding steps in the marketspace – more quickly, more eƒfectively, with more flexibility, and at lower cost. In other words, managers can begin to ask: What are we doing now in the place, and what could we do more eƒficiently or more eƒfectively in the space? What value-adding steps currently performed in the physical value chain might be shiƒted to the mirror world of the virtual value chain? When companies move activities from the place to the space, they begin to create a virtual value chain that parallels but improves on the physical value chain. Executives at Ford Motor Company engaged in such work during the past decade as the company aggressively adopted videoconferencing and EXPLOITING THE VIRTUAL VALUE CHAIN 26 THE McKINSEY QUARTERLY 1996 NUMBER 1 Companies begin to create a virtual value chain that parallels but improves on the physical value chain
EXPLOITING THE VIRTUAL VALUE CHAIN CAD/CAM technologies. When Ford developed its"global car"(marketed in North America as the Contour sedan), it moved one key element of the physical value chain- product development -into the marketspace. Ford intended to create a car that would incorporate its best engineering, design and marketing talent worldwide, while also bringing to bear a vision of how a single car design could appeal to all major world What value-adding steps currently performed in the markets at once physical value chain might be shifted to the mirror world To gain leverage from its substantial invest ments in marketspace-enabling technology of the virtual value chain? stems, Ford brought together managerial talent from around the world in the marketspace. Rather than creating national product teams or convening elaborate design summits, Ford established a virtual work team to develop the car. In this way, it set to work the best talent and the broadest vision it could muster By moving product development from the place to the space, Fords managers did more than perform tasks in an information-defined world that were traditionally accomplished through physical actions. In the virtual world, the design team could transcend the limitations of time and space that characterize management in the physical world. They built and tested prototypes in a simulated computer environment and shared designs and data with colleagues around the world over a computer network 24 hours a day. In the virtual world of information, they established common global specifications for manufacturing, integrated component systems centrally, and even drew suppliers into the design process. Ford thus performed critical value-adding steps not on the Pvc but on the VvC-in other words, in a world that mirrored traditional In the virtual world. the team managerial realities could transcend the limitations of time and space that With such a complete information- characterize the physical world based representation of the product, everyone on the team could see the project holistically in the mirror world. The goal: a global car with global appeal. The virtual value chain made a much more integrated process possible. The marketing challenge of getting customers to buy the Contour remains Managers at the Boeing Company took their exploitation of the mirror world one step further. A few years ago, they redesigned the engine housing for a new model of the 737 airplane. Previously, airplane manufacturers designed airframes by developing physical prototypes, testing them in wind tunnels to gauge the flow of air over their contours, and then repeating the process through multiple iterations When Boeing was debating how to THE MeKINSEY QUARTERLY 1996 NUMBER
CAD/CAM technologies. When Ford developed its “global car” (marketed in North America as the Contour sedan), it moved one key element of the physical value chain – product development – into the marketspace. Ford intended to create a car that would incorporate its best engineering, design, and marketing talent worldwide, while also bringing to bear a vision of how a single car design could appeal to all major world markets at once. To gain leverage from its substantial investments in marketspace-enabling technology systems, Ford brought together managerial talent from around the world in the marketspace. Rather than creating national product teams or convening elaborate design summits, Ford established a virtual work team to develop the car. In this way, it set to work the best talent and the broadest vision it could muster. By moving product development from the place to the space, Ford’s managers did more than perform tasks in an information-defined world that were traditionally accomplished through physical actions. In the virtual world, the design team could transcend the limitations of time and space that characterize management in the physical world. They built and tested prototypes in a simulated computer environment and shared designs and data with colleagues around the world over a computer network 24 hours a day. In the virtual world of information, they established common global specifications for manufacturing, integrated component systems centrally, and even drew suppliers into the design process. Ford thus performed critical value-adding steps not on the PVC but on the VVC – in other words, in a world that mirrored traditional managerial realities. With such a complete informationbased representation of the product, everyone on the team could see the project holistically in the mirror world. The goal: a global car with global appeal. The virtual value chain made a much more integrated process possible. The marketing challenge of getting customers to buy the Contour remains. Managers at the Boeing Company took their exploitation of the mirror world one step further. A few years ago, they redesigned the engine housing for a new model of the 737 airplane. Previously, airplane manufacturers designed airframes by developing physical prototypes, testing them in wind tunnels to gauge the flow of air over their contours, and then repeating the process through multiple iterations. When Boeing was debating how to EXPLOITING THE VIRTUAL VALUE CHAIN THE McKINSEY QUARTERLY 1996 NUMBER 1 27 What value-adding steps currently performed in the physical value chain might be shiƒted to the mirror world of the virtual value chain? In the virtual world, the team could transcend the limitations of time and space that characterize the physical world
EXPLOITING THE VIRTUAL VALUE CHAIN Exhiblt 2 Exploiting the virtual value chain Physical value chain Information capture Virtual value chain es from the e to the ma and with information In other words these information-based activities mirror steps in the create a new engine to improve the performance of its existing 737 airframe design, it turned not to wind tunnels but to a synthetic environment-a mirror world made of information. Boeing engineers developed the prototype as a virtual product that incorporated relevant laws of physics and materials sciences, enabling it to test an evolving computer-simulated model in a virtual wind tunnel As a result, engineers were able to test many more designs at dramatically lower costs and with much greater speed. The outcome was a teardrop shape for the engine housing that stunned the aerospace world. Only a process capable of endlessly testing different possibilities at near-zero incremental cost per synthetic prototype When scale economies do not could have given rise to a product concer apply, managers seeking better that so emphatically transcended conven- performance at lower cost tional thinking. By moving elements of the can tap the mirror world PVC-R&D, product design, prototyping, and product testing-to the mirror world of the VvC, Boeing succeeded battering dominant paradigm of engine design and delivered a product that easily outperformed the competition, a feat that had proved impossible in 20 years of wind-tunnel testing Every manager knows that staying competitive today depends on achieving higher levels of performance for customers while reducing costs in R&D and production. Traditionally, companies have gained more for less by exploiting vast economies of scale in production while focusing on raising levels of quality. Japanese automakers such as Toyota have successfully pursued this strategy, delivering highly differentiated products at the lowest possible cost. When scale economies do not apply, as in many service-sector businesses, managers seeking better performance at lower cost can tap the mirror world, in which the economics are altogether different. On the vvC, companies may find dramatic low-cost approaches to delivering extra ordinarily high-value results to customers. 28 THE McKINSEY QUARTERLY 1996NUMBER
create a new engine to improve the performance of its existing 737 airframe design, it turned not to wind tunnels but to a synthetic environment – a mirror world made of information. Boeing engineers developed the prototype as a virtual product that incorporated relevant laws of physics and materials sciences, enabling it to test an evolving computer-simulated model in a virtual wind tunnel. As a result, engineers were able to test many more designs at dramatically lower costs and with much greater speed. The outcome was a teardrop shape for the engine housing that stunned the aerospace world. Only a process capable of endlessly testing diƒferent possibilities at near-zero incremental cost per synthetic prototype could have given rise to a product concept that so emphatically transcended conventional thinking. By moving elements of the PVC – R&D, product design, prototyping, and product testing – to the mirror world of the VVC, Boeing succeeded in shattering a dominant paradigm of engine design and delivered a product that easily outperformed the competition, a feat that had proved impossible in 20 years of wind-tunnel testing. Every manager knows that staying competitive today depends on achieving higher levels of performance for customers while reducing costs in R&D and production. Traditionally, companies have gained more for less by exploiting vast economies of scale in production while focusing on raising levels of quality. Japanese automakers such as Toyota have successfully pursued this strategy, delivering highly diƒferentiated products at the lowest possible cost. When scale economies do not apply, as in many service-sector businesses, managers seeking better performance at lower cost can tap the mirror world, in which the economics are altogether diƒferent. On the VVC, companies may find dramatic low-cost approaches to delivering extraordinarily high-value results to customers. EXPLOITING THE VIRTUAL VALUE CHAIN 28 THE McKINSEY QUARTERLY 1996 NUMBER 1 When scale economies do not apply, managers seeking better performance at lower cost can tap the mirror world Information capture Exploiting the virtual value chain Exhibit 2 Physical value chain Virtual value chain With an integrated information underlay in place, companies can begin to perform value-adding activities more efficiently and effectively through and with information. In other words, these information-based activities mirror steps in the physical value chain. When companies move a number of value-adding activities from the marketplace to the marketspace, they exploit a virtual value chain
EXPLOITING THE VIRTUAL VALUE CHAIN New customer relationships Ultimately, however, companies must do more than create value in the space hey must also extract value from it. They can often do so by establishing space-based relationships with customers Once companies become adept at managing their value-adding activities across the parallel value chains, they are ready to develop these new relationships. In the world of high technology, examples of building customer relationships on the VvC abound. Today, thousands of companies have established sites on the World Wide Web to advertise products or elicit comments from customers. Some companies have gone further and have actually automated the interface with the customer, thus identifying and fulfilling customers' desires at lower cost Digital Equipment Corporation, making a comeback from its slump in the late 1980s, has developed a new channel for serving customers on the Internet. DEC's World Wide Web site allows prospective customers to use a personal computer to contact sales representatives, search for products and services, review the specifications of DEC equipment, and actually take a DEC machine for a"test drive. "Similarly, Oracle Corporation, a database software maker, now distributes a new product over the Internet as well a through physical channels. These companies are joining the burgeoning ranks of major high-tech firms in the business-to-business sector that have become Internet marketers; the group includes GE Plastics, Sun Microsystems, and Silicon Graphics, all of which use the Web to establish and maintain relationships with selected accounts Managing information allows companies to create new value Other companies view their challenge as for customers by serving a that of managing each individual customer broader set of their needs relationship in both the marketspace and the marketplace. Those that succeed have an opportunity to reinvent the core value proposition of a business, even an entire industry. One extraordinary example is United Services Automobile Association, which has truly maximized its opportunities to deliver value to customers in both he space and the place and has thereby become a world-class competitor. USAA began as an insurance company. Over time, it has used its infor mation systems-installed to automate its core business, insurance sales and underwriting -to capture significant amounts of information about customers, both individually and in aggregate. USAA has integrated this information and distributed it throughout the company so that employees are ready to provide products, services, and advice whenever a customer contacts the company. Having make this investment in visibility, it found that, among other things, it could prepare customer risk profiles and THE McKINSEY QUARTERLY 1996 NUMBER
New customer relationships Ultimately, however, companies must do more than create value in the space: they must also extract value from it. They can oƒten do so by establishing space-based relationships with customers. Once companies become adept at managing their value-adding activities across the parallel value chains, they are ready to develop these new relationships. In the world of high technology, examples of building customer relationships on the VVC abound. Today, thousands of companies have established sites on the World Wide Web to advertise products or elicit comments from customers. Some companies have gone further and have actually automated the interface with the customer, thus identifying and fulfilling customers’ desires at lower cost. Digital Equipment Corporation, making a comeback from its slump in the late 1980s, has developed a new channel for serving customers on the Internet. DEC’s World Wide Web site allows prospective customers to use a personal computer to contact sales representatives, search for products and services, review the specifications of DEC equipment, and actually take a DEC machine for a “test drive.” Similarly, Oracle Corporation, a database soƒtware maker, now distributes a new product over the Internet as well as through physical channels. These companies are joining the burgeoning ranks of major high-tech firms in the business-to-business sector that have become Internet marketers; the group includes GE Plastics, Sun Microsystems, and Silicon Graphics, all of which use the Web to establish and maintain relationships with selected accounts. Other companies view their challenge as that of managing each individual customer relationship in both the marketspace and the marketplace. Those that succeed have an opportunity to reinvent the core value proposition of a business, even an entire industry. One extraordinary example is United Services Automobile Association, which has truly maximized its opportunities to deliver value to customers in both the space and the place and has thereby become a world-class competitor. USAA began as an insurance company. Over time, it has used its information systems – installed to automate its core business, insurance sales and underwriting – to capture significant amounts of information about customers, both individually and in aggregate. USAA has integrated this information and distributed it throughout the company so that employees are ready to provide products, services, and advice whenever a customer contacts the company. Having make this investment in visibility, it found that, among other things, it could prepare customer risk profiles and EXPLOITING THE VIRTUAL VALUE CHAIN THE McKINSEY QUARTERLY 1996 NUMBER 1 29 Managing information allows companies to create new value for customers by serving a broader set of their needs
EXPLOITING THE VIRTUAL VALUE CHAIN customize policies on the vVC. Looking at the flow of information harvested along its VVC, USAAs managers invented business lines targeted to the needs of specific customers, such as insurance for boat owners. But the company also used its growing expertise with information to create new value for customers in areas that had little or nothing to do with insurance. It went one step further for boat owners, for example: it designed financing packages for purchasing boats. In fact, USAA now offers a wide range of financial products as well as shopping services for everything from jewelry to cars. Further, when a customer calls in with a theft claim, the company can offer to send a check or replace the stolen item.(Many customers opt for the latter because it involves less work and solves their problem By aggregating demand statistics and likely loss ratios, USAA has become a smart buyer for its loyal customer base, winning discount prices through high-volume purchases and passing some or all of the saving along to the customer. Today, USAA is one of the largest direct merchandisers in the United States, shipping real goods along its PVC as directed by the sensing capabilities of its vVC. Yet the company does not actually manufacture anything. Rather, it is a trusted intermediary Each stage of the virtual value between the demand it senses and the chain allows for many new supply it sources extracts from the information Although USAAs"product line"is eclectic, each of which could constitute it represents a logical, cost-effective, and a new product or service profitable progression of new business ven tures, all of which are underwritten by the information about customers captured in the company's virtual value chain Managing that information has become USAAs central activity. Through clever integration of the information harvested along the vvC and through a PVC that delivers goods and services, it creates new value for customers b serving a broader set of their needs The value matrix The new relationships that companies such as USAA are developing with customers spring from a matrix of value opportunities. Each stage of the virtual value chain-as a mirror of the physical value chain- allows for many new extracts from the flow of information, each one of which could constitute a new product or service. If managers want to pursue any of these opportunities, they need to put into place processes to gather the information, organize it for the customer, select what's valuable, package(or synthesize)it, and distribute it- the five value-adding steps unique to the information world. In effect, these value-adding steps, in conjunction with 30 THE McKINSEY QUARTERLY 1996 NUMBER
customize policies on the VVC. Looking at the flow of information harvested along its VVC, USAA’s managers invented business lines targeted to the needs of specific customers, such as insurance for boat owners. But the company also used its growing expertise with information to create new value for customers in areas that had little or nothing to do with insurance. It went one step further for boat owners, for example: it designed financing packages for purchasing boats. In fact, USAA now oƒfers a wide range of financial products as well as shopping services for everything from jewelry to cars. Further, when a customer calls in with a theƒt claim, the company can oƒfer to send a check or replace the stolen item. (Many customers opt for the latter because it involves less work and solves their problem.) By aggregating demand statistics and likely loss ratios, USAA has become a smart buyer for its loyal customer base, winning discount prices through high-volume purchases and passing some or all of the saving along to the customer. Today, USAA is one of the largest direct merchandisers in the United States, shipping real goods along its PVC as directed by the sensing capabilities of its VVC. Yet the company does not actually manufacture anything. Rather, it is a trusted intermediary between the demand it senses and the supply it sources. Although USAA’s “product line” is eclectic, it represents a logical, cost-eƒfective, and profitable progression of new business ventures, all of which are underwritten by the information about customers captured in the company’s virtual value chain. Managing that information has become USAA’s central activity. Through clever integration of the information harvested along the VVC and through a PVC that delivers goods and services, it creates new value for customers by serving a broader set of their needs. The value matrix The new relationships that companies such as USAA are developing with customers spring from a matrix of value opportunities. Each stage of the virtual value chain – as a mirror of the physical value chain – allows for many new extracts from the flow of information, each one of which could constitute a new product or service. If managers want to pursue any of these opportunities, they need to put into place processes to gather the information, organize it for the customer, select what’s valuable, package (or synthesize) it, and distribute it – the five value-adding steps unique to the information world. In eƒfect, these value-adding steps, in conjunction with EXPLOITING THE VIRTUAL VALUE CHAIN 30 THE McKINSEY QUARTERLY 1996 NUMBER 1 Each stage of the virtual value chain allows for many new extracts from the information, each of which could constitute a new product or service