Boundary business

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Traditional boundaries around companies and industries are dissolving. But this does not mean that we live in a world without boundaries.

It is a truism of modern business that the traditional boundaries around companies and industries are dissolving. We see the convergence of computing and telecommunications. New delivery channels demand the restructuring of media businesses. Traditional demarcations in both wholesale and retail markets for financial services are disappearing.

But this does not mean that we live in a world without boundaries: that there are no rules; that anything goes. The principles that define the boundaries of companies and industries remain unchanged, even if they have different implications as technology changes and markets evolve.

The basic unit of analysis in business economics is the production activity. These activities take place in individual operating businesses, and it is usually in such operating businesses that competitive advantages are found. Many relate to production: innovation, process efficiencies, supplier relationship. Others – such as brands and reputations – are the result of the position of a company in its markets. It is the markets and activities in which the company holds competitive advantages that define its boundaries. And the set of production activities that have common sources of competitive advantage which describes the boundaries of the industry.

Insurance companies used to be classified into brokers, general insurers and reinsurers. But as insurance products have evolved, these divisions no longer match the different activities of the industry.

Insurance is about the exchange of risk, and the assumption of risk is the activity of underwriting. Risk management assesses risks and identifies how it can be reduced and where it can best be underwritten. It is largely a business-to-business matter. The business-to-consumer dimension of insurance is another distinct activity, insurance retailing.

Underwriting, risk management and retailing demand very different skills. Most underwriting requires the professional mathematical abilities in which Swiss and German reinsurers have excelled. An occasional willingness to take on idiosyncratic risk requires the characteristic brio of the successful Lloyds underwriter. Risk management is akin to other forms of management consultancy and demands the same kinds of personal and intellectual attributes. Retailing insurance needs the same skills as retailing other financial services — which in turn involve the same skills as retailing groceries or clothes.

The traditional corporate structure of the insurance business is being redrawn around these distinct activities. Insurance brokers have polarised into corporate consultancy businesses, like Marsh, or into true retailers. The retailers are increasingly integrated into other retail financial service businesses, such as retail banks. General insurance companies, which have in the past undertaken all three activities without honing specific skills in any of them, are losing ground to specialists in every segment. Today these general insurers they are searching for a role, with increasing desperation.

The insurance business is boundaryless only for those who cannot see new boundaries being drawn. The same is true of media businesses. The boundaries of media businesses are changing as different media converge and new electronic media grow rapidly.

Yet there is a common structure to most media industries. The book business divides into authors, who originate material: printers and booksellers, responsible for its delivery: and publishers, who are responsible for selection, financing, marketing and the co-ordination of the whole process. Very different activities, with quite different types of competitive advantage.

Indeed that division into origination, co-ordination and delivery is a common structure for many service industries. Originating talent — stars, producers, directors — form one sector of the movie businesses. There are delivery businesses in cinema exhibition and video distribution. Studios act as publishers, providing the same services to their business as book publishers to their industry — selection, financing, marketing and co-ordination.

Only electronic media have differed from this structure, because of the historic scarcity of the means of delivery. So long as terrestrial broadcasting was the only means of delivering electronic signals to homes, terrestrial broadcasters dominated the whole value chain. They took exclusive control of electronic publishing and kept down the earnings of originating talent. Today their monopoly has gone, and broadcasters have to pay originating talent — such as football clubs and their players — what that talent is worth. When the fog has cleared the industry will have restructured itself around origination, publishing and delivery.

Banks engage in a collection of activities linked by historic accident. They once collected small savings to lend to large companies. But the modern financial market means there is no necessary connection between these activities. So banking is also reorganising itself. Component activities include retailing, transmission and payment systems, lending, investment. In a generation, banks as we know them will have disappeared. Instead there will be a group of financial services retailers whose technology will be outsourced to companies with the different skills needed to manage huge databases. Other businesses will capitalise on the competitive advantages needed for profitable small business lending or in fund management.

Identify the component activities and you will identify the emerging market structure. The most common mistake is to believe that the necessary answer to convergence is conglomeration. Far from it: changing technology and markets mean that old conglomerates lose their rationale. This is the fate of general insurance companies, traditional broadcasters, and banks, all of which face steady decline as the boundaries of their companies no longer match the frontiers of their industries.

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