The economics, structure, and behavior of platform ecosystems and organizations

The world-renowned management theorist Gary Hamel and his collaborator Michele Zanini published a magisterial analysis of the huge innovations at Haier over the past decade by 'renegade CEO' Zhang Ruimin. In The End of Bureaucracy, the authors provide perhaps the single best synopsis of Haier's revolution from an organizational structure and development perspective, with an admixture of Hamel's bête noire: bureaucracy. The authors make a strong case for the damage that bureaucratic management has made, starting with our inclination to accept it as a necessary evil:

Though mindful of its evils, many people believe bureaucracy is unavoidable. [CEO of JPMorgan Chase Jamie] Dimon remembers an outside adviser who defended it as the “necessary outcome of complex businesses operating in complex international and regulatory environments.” Indeed, since 1983 the number of managers, supervisors, and administrators in the U.S. workforce has grown by more than 100%, while the number of people in all other occupations has increased by just 44%. In a survey by Harvard Business Review, nearly two-thirds of respondents said their organizations had become more bureaucratic in recent years. Peter Drucker’s prediction that today’s organizations would have half as many layers and one-third as many managers as their late-1980s counterparts was woefully off the mark. Bureaucracy has been thriving.

Meanwhile, productivity growth has stalled. From 1948 to 2004, U.S. labor productivity among nonfinancial firms grew by an annual average of 2.5%. Since then its growth has averaged just 1.1%. That’s no coincidence: Bureaucracy is particularly virulent in large companies, which have come to dominate the U.S. economy. More than a third of the U.S. labor force now works in firms with more than 5,000 employees—where those on the front lines are buried under eight levels of management, on average.

Startling numbers, and bureaucracy may turn out to be a contributing factor in the seemingly intractable productivity paradox today (see The Limits of Digital: Ideas, Creativity, and Cultural Reformation). The authors of The End of Bureaucracy set up bureaucracy as an enormous dead weight that management fails to rid itself of, and then they hold up Haier as an enterprise that has rejected the premises and poisons of bureaucracy through the creation and roll-out of Rendanheyi, Haier's antidote to bureaucracy. As the authors style it,

Having long viewed bureaucracy as a competitive liability, Zhang Ruimin, Haier’s renegade CEO, has for a decade led an effort to build a company where everyone is directly accountable to customers (a policy he describes as “zero distance”), employees are energetic entrepreneurs, and an open ecosystem of users, inventors, and partners replaces formal hierarchy.

Haier’s shorthand for these practices is rendanheyi, a mash-up of Chinese characters that connotes a tight coupling of the value created for customers with the value received by employees.

A Larger Framework

Before summarizing Hamel and Zanini’s analysis of how Haier has diverged from traditional management thinking, I'll take a step back and put the authors' analysis in a slightly larger framework.

In the Venn Diagram below, I present a model with three domains in the discourse around platform ecosystems and the organizations that they support:

  1. Organization — A perspective that focuses on organizational theory, development, design, and structure; the relationship of the individual to the organization and its management cadre; the market competition between businesses; and the relationship of businesses with their customers.
  2. Organism — A perspective based on theories from complexity and chaos theory, ecology, and self-organization principles, such as those that motivate social networks (not Twitter and Facebook, but human social networks), as well as complexity economics, bioeconomics, biopolitics, and cognitive science.
  3. Inorganism — A perspective rooted in classic scarcity-obsessed economics and related linear and mechanistic 'steady state' models that model the world through the lens of  simplifying assumptions that are not based in observable facts, such as the belief in homo economicus who makes decisions 'rationally', and simple feedback-based models that do not account for the emergent behaviors of complex systems.

There are large overlaps in these viewpoints: they are not inherently antagonistic, but any commentator that only views the world through a single lens will not gain the compounding value of a blending of perspectives. Still, everyone is contextually situated in the world, and theoreticians are as human as anyone else, so their thinking starts from earlier considered beliefs. Many of the difficulties in understanding, discussing, or comparing platform ecosystems and their organizational impacts arise from conceptual mismatches in the mental models of these three domains, as well as the tendency of practitioners to have widely varying depth of knowledge in the three domains.

For example, Hamel's The End of Bureaucracy approaches the story of Haier from the viewpoint of organizational theory, as an overturning of the conventions of 'normal business', while only touching lightly on the emergent order and non-linear scaling inherent in Haier's formulation of platform ecosystems. This does not diminish the author's insights and analysis, but they tend to cluster in the Organization sphere in the Venn diagram above.

Hamel and Zanini's Analysis

In their thoughtful analysis in the November-December 2018 issue of Harvard Business Review, Hamel and Zanini contrast Haier's structure and dynamics as an organization evolution. That is a similar approach to the one I did in Evolution of the Platform Organization: What We Can Learn From Haier. In this article, I liberally summarize their analysis using their original structure and subheadings that describe the seven ways Haier departed from traditional management thinking, and add my own observations and critiques.

From Monolithic Businesses to Microenterprises — Hamel and Zanini describe how Haier has turned to a model of microenterprises (MEs) to break up monolithic line-of-business divisions and functional vertical silos. The resulting network of small, interdependent but largely autonomous MEs, can team up, spin out new MEs, and, importantly, create relationships with groups and individuals outside the formal boundaries of the corporation. Hamel and Zanini describe three types of ME: 200 that are in the process of transitioning to the new model of business, 50+ that act as new business start-ups, and 3,800 ‘nodes’ that provide services like HR and manufacturing to the other two types.

From Incremental Goals to Leading Targets — Haier's MEs create their annual objectives 'outside in', driven by market trends and incorporating historic company performance:

Market-facing MEs are expected to grow revenue and profit four to 10 times faster than the industry average. In product categories where Haier lags, the bar is set the highest, since there’s plenty of room to increase share. In areas where Haier leads, the target is more modest but still a multiple of the market baseline.

And the foundation of the revolution at Haier:

Every market-facing ME is also expected to make a transformative leap from selling products and services to building an ecosystem.

Each ME develops an analysis of customer involvement in product development, an analysis of unique customer value, and the contribution of the ecosystem to ME goals.

From Internal Monopolies to Internal Contracting — By making internal operations and services into a market, Haier has reintroduced market dynamics:

At Haier every ME is free to buy services, or not, from other MEs. (A typical user ME will have agreements with dozens of nodes.) If an ME believes that an external provider would better meet its needs, it can go outside for services.

MEs assess their needs on an annualized basis, and then ask for and receive multiple bids from node MEs for the services desired. To decrease friction and increase fairness, Haier has instituted predefined protocols about margin sharing and minimum performance standards. A high degree of fluidity is the norm, and helps weed out ineffective MEs.

Zhang has often said that 'At Haier we are no longer paying our employees. Instead, they are paid by customers'.  Customer-facing MEs get their compensation directly from customer sales, and supporting MEs suffer if an ME it supports fails to meet its goals.

From Top-Down Coordination to Voluntary Collaboration — Hamel and Zanini detail how Haier coordinates large-scale initiatives (like manufacturing automation and new product line development) by aggregating like MEs into platforms, such as the refrigerator platform show below. Customer-facing MEs rely on ‘competence-focused platforms', such as smart manufacturing and marketing. This means the MEs do not have to build up their own mini-marketing organization, but can rely on the 100-person marketing platform that supplies customer information.

One of the on-going projects here at On The Horizon will be to develop consistent representations of ecosystems and their more elementary components: their anatomy and physiology at different scales. Hamel and Zanini’s illustration suggest only a small part of the dynamics and interrelatedness of the Haier ecosystem.

The platform owner is charged with increasing cooperation, such as finding common purpose in research and development activities or jointly developing new products. I am reminded of the role of movie producers, who orchestrate huge productions by pulling together the right director, writers, actors, musicians, and so on, and help to crease impediments to success for all involved.

From Rigid Boundaries to Open Innovation — Perhaps the most anti-bureaucratic element of Zhang's vision is breaking down the barriers to bringing in outsiders — non-employees — to help the company innovate. All new products and services are developed on an open innovation approach, involving potential users of the envisioned product — in one case using Baidu’s social media site for more than 30 million responses on features and needs — and a 400,000 plus global network of technical experts and institutional solvers.

Hamel and Zanini spell it out:

By moving its product development process online, Haier has reduced the time from concept to market by up to 70%. Manufacturing and design nodes, user MEs, potential customers, and business partners work in parallel throughout, starting with the earliest discussions about customer needs. That maximizes creative problem solving and minimizes the risk of clumsy handoffs as the product moves toward launch. While many executives view their businesses as linear value chains, beginning with R&D and ending with sales and support, Haier sees them as value networks in which all parties collaborate at every stage.

I see a familiar formula: networks + online platform = ecosystem. Unsurprisingly, Haier uses this approach to find new talent. Many MEs were started by participants who made great contributions as non-employees. On The Horizon will do a deep dive into the Haier Open Partnership Ecosystem (HOPE) that facilitates the approach.

From Innovation Phobia to Entrepreneurship at Scale — The Haier approach unlocks the gates blocking innovation, and replaces them with an ecosystem approach that scales non-linearly and reduces the cost of insights to near zero. Haier operates as a start-up incubator, where MEs get stared by either an idea posted by an internal entrepreneur that invites participants, a platform owner seeking bids, or monthly road shows for external entrepreneurs. Once kicked off, all new MEs are made separate legal entities, funded in part by the founders, but often reinforced by external funding from outside venture partners.

As Hamel and Zanini point out, it's a numbers game:

The only way to find that next billion-dollar opportunity is to launch a slew of start-ups and give each one the freedom to chase its dream.

From Employees to Owners — These start-up founders and others involved in incubating MEs ‘feel and act like owners’ by deciding on strategy, defining roles and relationships, and setting pay rates and bonuses. Common to start-ups, base salaries are low and employees are incented by performance goals for bonuses, dividends, and profit sharing. With such skin in the game, ME teams have little tolerance for poor leaders, who are chosen competitively in the first place, and who are deposed if things go off the rails.

As the authors state, unlike modern bureaucratic, top-down organizations, who provide only modest upside opportunities for the rank-and-file,

Haier does everything possible to turn employees into owners. It is here that one finds the deepest explanation for Haier’s track record of industry-beating growth and innovation.

Hamel and Zanini's Conclusion

The authors cast what Haier has accomplished in terms of the radical departure from the traditionalist, bureaucratic operating model that still dominates business today:

Thirty years ago the company was a struggling collective enterprise turning out products of dubious quality. Today it’s a case study in what can be accomplished when an established company is willing to challenge bureaucracy’s authoritarian structures and rule-choked practices. Who would have imagined that it’s possible to run a large global business with just two layers of management between frontline teams and the CEO?

My sense is that Zhang was driven by his dramatically different vision of the relationships between individuals connected through commerce more than by a desire to unmake bureaucracy. That vision starts with the relationship between the customer and the company, which he sees as a customer connection with frontline entrepreneurial workers rather than an institutional brand. Indeed, that is one of the concepts embedded in Rendanheyi, the zero distance between customers and the company. But his vision extends to the relationships between the frontline and back office workers, across the newly created networks of solvers that accelerate innovation, and a dramatically reconstructed notion of hierarchy.

Yes, platform owners inhabit a region between the CEO and the leaders of the myriad MEs in Haier, but they operate more like venture capitalists, market regulators, and referees than divisional managers. Platform owners don't direct the activities of ME owners, who are not subordinates, per se, but more like franchisees, or partners in a supply chain. The platform owners (and the CEO, as well) are investing their energies to create new experiments to pursue new opportunities, and to creating a context in which ME leaders and workers can be successful in those experiments. And in all cases, they are not 'managing': they are not telling people what to do, or how to do it. They are gardeners, making the soil healthy, keeping away pests, planting seeds, watering and weeding, and helping the new shoots grow. So, I think it's a mistake to refer to 'two layers of management' between the CEO and the ME.

But Hamel and Zanini are dead on with this insight:

For decades, most companies have worked diligently to optimize their operations. More recently, they’ve raced to digitize their business models. Important as this is, Haier has done something even more consequential: It has humanized its management model.

And Zhang states this clearly, as the authors note:

We want to encourage employees to become entrepreneurs because people are not a means to an end but an end in themselves. Our goal is to let everyone become their own CEO—to help everyone realize their potential.

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