Businesses are changing the way they’re organized.

The more traditional model of hierarchical supply chains is increasingly being replaced by business ecosystems- a dynamic group of independent partners that work together to deliver integrated products and services.

The main reasons for the ecosystem-model becoming popular is that an ecosystem provides quick and cheap access to capabilities that may be too expensive or time-consuming to build for a single firm, and it can scale fast thanks to its modular structure that makes it easy to add partners. Moreover, ecosystems are flexible and resilient, able to adapt and pivot according to consumers’ needs.

Yet 85% of business ecosystems fail. Furthermore, corporates get frustrated when the ecosystems don't produce large profits after a few years of engagement.

To understand how to improve the odds of success and define appropriate metrics to detect if the ecosystem is still on track and healthy, Ulrich Pidun, together with other experts within the BCG Henderson Institute, analyzed more than 100 failed ecosystems in a variety of industries and compared them with their more successful industry peers, using a systematic quantitative and qualitative analysis.

Their database contains B2C, C2C, and B2B ecosystems and includes social networks, marketplaces, software solutions, and payment, mobility, entertainment, and health care services. On average, the ecosystems studied had existed for 6,8 years and had raised funding of $185 million.

During our recent Innov8rs Connect on Startup Collaboration & Ecosystem Engagement, Ulrich shared the key findings of this research. He highlighted the success metrics and red flags to consider to determine whether an ecosystem is still on track to success in its different lifecycle phases.

What’s the Definition of Ecosystem?

It’s of course important to clarify what we mean when we talk about “ecosystem”. While this may seem like a straightforward question, defining what an ecosystem is can be complicated, and it’s usually difficult to find common ground. According to Ulrich, there are two basic definitions:

  • Ecosystems as affiliation: ecosystems as communities of associated players defined by their networks and affiliation (e.g., Google and its network of partners, clusters like Silicon Valley or the Boston biotech cluster). In this case, an ecosystem is a group of partners, a community of associated players, mainly defined by the network they constitute and the affiliations they have.
  • Ecosystems as structure: ecosystems are configurations of activities defined by their value propositions. In this second case, the ecosystem is a structure organized to achieve a certain value proposition, a specific purpose. Mobile operating systems and their application development partners fall into this (e.g., Android, Apple iOS), but also marketplaces like eBay, Uber, and Airbnb.

Ulrich’s session focuses on the second definition. He specifies that there's no more correct definition, but “ecosystem as a structure” is a more narrow concept and makes it more distinct from other ways of organizing. In a nutshell, it’s more useful. Accordingly, Ulrich defines a business ecosystem as a dynamic group of largely independent economic players that create products and services that together constitute a coherent solution. A business ecosystem is a dynamic group (which can change in composition) of independent players who work together to create something bigger than the sum of the parts.

Thus, it turns out that ecosystems are just one way of organizing a business – they compete with other ways of organizing.

When is an ecosystem the preferred way to organize a business (and when is it not)?

The ecosystem is the preferred governance model when high modularity comes together with a high need for coordination. And so, if the solution to a business problem can be broken down into reasonably independent and easy-to-combine modules and, at the same time, coordination is needed to find the best combination, this is the sweet spot for ecosystems.

Otherwise, with high modularity but a low need for coordination, an open market model (i.e., a model where every player works independently and the consumer decides how to combine the different elements) is more likely to succeed. Low modularity and high need for coordination call for a vertically integrated model, while low measures on both drivers work best in a more hierarchical organization.

Business ecosystems have strong benefits…

What makes ecosystem models even more interesting, it's three associated benefits:

  • Access to new capabilities: thanks to ecosystems, access to capabilities is quicker and cheaper. That's how Apple succeeded with the iPhone. Initially, Steve Jobs was very clear that he wouldn't allow external developers to develop applications. Only nine months after its launch, Apple opened the App Store and the iPhone really took off. “It's this access to new capability, positive surprises, decentral innovation that make the ecosystem attractive”, says Ulrich.
  • Ability to scale fast: thanks to the modular structure of ecosystems, it's easy to add additional, light modules and grow this way. That's how Airbnb became larger in offering overnight stays than all hotel chains combined within just a period of 10 years. And that's only possible in an ecosystem model.
  • Flexibility and resilience: due to their modular nature, it's easy to add and remove elements if customer preferences change. During the COVID crisis, Airbnb performed much better than the average hotel chain because it was much quicker in adapting to moving from urban to rural offerings and also offering virtual events on the platform. That’s definitely easier in an ecosystem context.

… but also different economics than traditional businesses

Ecosystems are different, and it’s important to understand the difference in their economics. Most traditional models are characterized by diminishing returns: the value per user decreases as the number of users grows. The overall value may still increase, but the marginal user has smaller benefits than the initial users. Yet this doesn't apply to ecosystems that typically have increasing returns: the value per user increases as additional users join the ecosystem.

What drives these increasing return are, its three flywheels effects:

  • Network effects: more users generate more partners, thus improving the value proposition and attracting more users.
  • Learning (or data) effects: that's the secret sauce of many very successful ecosystems – the more users, the more the data, the deeper and better the insights, the more promising the value proposition, which will again attract more users.
  • Economies of scale (cost flywheel): this third flywheel is sometimes forgotten, but it's essential. More users help spread the fixed costs and get unit costs down, allowing participants to lower prices and improve the value proposition, which will then attract more users.

Interestingly, many seemingly successful ecosystems get the first two flywheels going but not the third one. It follows that they can grow and maybe even dominate their markets but have a hard time earning a decent profit. A striking example is the online food delivery players: they benefit from network and learning effects but have difficulty getting costs down.

Unlike more traditional businesses, there's usually a long period where the value is not as apparent in most ecosystem ventures. In their analysis, Ulrich and the other experts have seen that the average time to achieve a critical mass and benefit commercially is 6,8 years, even for the most known and successful ecosystems. For instance, Amazon took more than a decade before they started to earn reasonable profits.

This feature makes joining ecosystems challenging, particularly for many incumbent firms: the ecosystem doesn't look very promising in the first years. “That's something to keep in mind when we talk about measuring success because. Obviously, financial metrics are not enough”, warns Ulrich.

Why Do Business Ecosystems Fail?

In their research, Ulrich and colleagues looked at a large number of ecosystems and tried to find as many positive and negative examples. And they concluded that only 15% of ecosystems were sustainable in the long run, while the others failed sooner or later, either because they never took off or didn't evolve the model. And while this is not an unusual number for venture efforts, the problem with ecosystems is that they tend to fail late.

The analysis shows that only 30% of the ecosystem failed during the launch phase, which means that more than two-thirds made it into the scale phase, and even a quarter made it beyond the scale phase into the maturity and evolution phase before they actually failed. And there, it becomes expensive to fail.

At this point, a dilemma arises: does it pay to wait to reach the point of critical mass and take off or instead pull the plug earlier than later? Answering this question is complex. Yet the first step if you manage, invest in, or join an ecosystem model, is to understand if that ecosystem is still healthy and on track.

Ulrich thinks that if we want to understand if we are at risk, we need to understand why ecosystems fail and the key reasons for failure first. And the analysis based on 100+ failed ecosystems shows that:

  • 34% fail because of wrong governance choices in terms of either being too open and losing your quality or being too closed and killing your growth. Finding an acceptable balance between being open and being closed is critical.
  • 18% fail because of wrong ecosystem configuration: it’s challenging to convince all the critical partners to join your ecosystem. Unlike more traditional ways of organizing, ecosystems need not only a strong customer value proposition but also a strong partner value proposition.
  • 10% fail because of insufficient problems to solve: customer value proposition is just not big enough to justify such an ecosystem investment. As the orchestrator of an ecosystem, you need to be profitable yourself and allow all the other partners to be profitable.
  • 10% fail because of weak defensibility: achieving a substantial market position also means having the ability to defend it.
  • Minor reasons to fail are inadequate monetization (5%) and wrong launch strategy (8%)

To avoid these strategic mistakes in designing an ecosystem, you need to identify the problems early enough to react.

What metrics can companies use to assess ecosystem success and detect if they're still on track?

Typically two types of metrics are used to assess ecosystems, but both are mostly useless:

  • Traditional financial metrics – e.g., revenues, cash burn rate, profitability, ROI. Since they are backward-looking, they’re not very useful for assessing prospects and future probability of success of ecosystems.
  • Vanity metrics – e.g., market size, number of subscribers, click rate, social media mentions. These can be misleading because they’re more related to the size of the opportunity and not necessarily linked to value creation or extraction.

According to Ulrich, ecosystems’ success metrics should focus on their lifecycle phases. Depending on the stage you are in, very different success factors, ambitions, and metrics are needed:

1. Launch phase

During the launch phase, the aim should be to prove the concept's viability and start establishing the ecosystem in the market by developing a strong value proposition for all participants (customers and partners) and finding the right initial ecosystem design. The key success metrics to understand the difference between successful and less thriving players in this first phase are:

  1. Number and engagement level of marquee partners: it's not so much the number of partners; it's about the number of the most relevant partners. It’s crucial to focus on the opinion leaders, the “stars” in their industry because they can attract other partners into the ecosystem. “You shouldn't be complacent if the number of partners just grows if it's the wrong type of partner”, warns Ulrich.
  2. Number and engagement level of high-value customers: similarly, it's not just the number of customers; it's the number of customers who will benefit most from the value proposition. For example, if you are a gaming platform, it's crucial to get the most engaged players on your platform – you don’t need subscribers, you need engaged subscribers who use your platform.
  3. Customer feedback: getting feedback is important in terms of net promoter score and ratings compared to competitors. And it also gives you a chance to listen to your customers and understand where the issues are with your platform, what they like, what they don't like, or what they miss. Typically, feedback helps pivot and adapt the offering and make it even more attractive. Accordingly, be prepared to push your idea into the market, listen to the market, and react to what you hear.

Aside from success metrics, some red flags may help understand what’s the health level of the ecosystem:

  1. Critical partners don't join your platform: that’s a huge problem. Ulrich mentions Better Place, a company that 15 years ago tried to solve the battery issue for electric vehicles. They offered a battery rent and a monthly subscription, and the interest from customers was high. Although they spent more than 900 million in funding and survived for seven years, the idea eventually failed because one type of critical partner, the auto manufacturers, didn't join the ecosystem.
  2. Some of your users subvert the value proposition: that’s something that YouTube, for instance, experienced in its early days as people were posting copyright content without noticing it. The platform started to have success only when YouTube enforced the copyright laws and defined monetization options for copyright holders.
  3. Key opinion leaders begin to leave the ecosystem: it doesn’t matter if the total number of partners and customers grows if marquee partners leave.
  4. The ecosystem’s core offering and/or scope is frequently changed: it’s a bad sign because it communicates that the initial core offering wasn't attractive enough. In many cases, it's better to give up rather than try to add additional bells and whistles to make it more attractive. All Ulrich’s studies show that the best way to grow an ecosystem is to keep the initial scope very limited and then add additional scope as the ecosystem grows.
2. Scale Phase

In the scale phase, the focus should be on increasing the number and intensity of interactions and growing the operating model towards profitability. Also, it would help if you focused on reducing the cost per interaction. Profitability shouldn't be much of a concern during the launch phase, but it becomes relevant during the scale phase. Accordingly, the key success metrics to look at to see if the ecosystem is succeeding during the scale phase are:

  1. Number of active customers
  2. Number of active partners
  3. Number of successful transactions
  4. Unit cost per transaction

Correspondingly there are a few red flags:

  1. Imbalance between participants on both sides of the market.
  2. Ecosystem growth reduces the value for one side of the market: this was experienced, for example, by Covisint, a B2B marketplace for automotive suppliers, which was heavily funded by the auto industry. As the ecosystem grew and more suppliers joined, their competition became much more severe. And it became much less attractive for them to be on this platform because prices would just be auctioned down. That was a flaw in the design of the ecosystem and, in the end, Covisint went out of business.
  3. Increasing number of users misuse the ecosystem.
  4. Quality indicators begin to decline: it's also important to be critical about quality indicators in the scale phase. MySpace, the predecessor of Facebook, allowed users to have anonymous profiles on the platform. That invited a lot of spam and even inappropriate content on the platform. And so, while the platform still scaled nicely in terms of the number of users, the quality went down, and important advertisement partners no longer supported the platform.
  5. The operating model does not scale: complexity increases as you grow, and you must be ready, adapt, and pivot. Yahoo, the first big search engine, was a manually curated engine with manual categorization of websites. This worked very well when the internet was still small. But when it exploded, there was no way that it could scale. The PageRank algorithm of Google was much stronger.
3. Maturity phase

In the maturity phase, you should focus on increasing customers' and suppliers' loyalty, consolidating your position, and defending your ecosystem against competitors by erecting entry barriers. This phase is about churn rates and retention: you can no longer grow revenues by growing the number of users. You need to grow revenue per user. Accordingly, the key success metrics are:

  1. Churn rates of customers/partners
  2. Revenue per customer
  3. Contribution margin per transaction
  4. Retention cost for customers/partners
  5. Acquisition cost for customers/partners

While the red flags to pay attention to (and pivot accordingly) are:

  1. Engagement level of customers or suppliers declines: that’s again what happened to MySpace.
  2. Early ecosystem adopters start to leave.
  3. Aggressive copycats and/or niche competitors emerge: for example, this is what UpWork is experiencing – it’s so successful that tons of other freelance working platforms are emerging.
  4. Partners begin to create competing platforms of their own.
  5. Successful ecosystems from other sectors expand into your field.
4. Evolution phase

In the evolution phase, once you have established yourself as a player and built defenses, you need to focus on how to advance and expand the offering and continuously innovate to thrive and survive in the long term. The major challenge here is that you made it to a point where your partners and customers may depend on you. And so you may become complacent and not reinvent yourself and improve your offering. In a nutshell, the evolution phase is about reinventing the ecosystem before others do it. The key success metrics in this last phase are straightforward but still not trivial:

  1. Share of revenue from new products or services
  2. Customer satisfaction
  3. Partner satisfaction

On their side, the red flags are:

  1. The orchestrator's take rate from partners rises.
  2. Partners increasingly complain about predatory behavior.
  3. Negative coverage in (social) media begins to accumulate.
  4. Legal actions against the ecosystem accelerate.

In summary. Ecosystems fail because of wrong governance choices, bad configuration, insufficient problems to solve, and weak defensibility. To increase the odds of survival, it's paramount first to understand that measuring the success of an ecosystem requires very different types of metrics compared to more traditional businesses.

As soon as you see a red flag, regardless of the phase you’re in, that may be a reason to pivot or exit your ecosystem and admit that you can no longer develop it into something sustainable. And according to Ulrich, the earlier you come to this conclusion, the better.