Academic journal article The McKinsey Quarterly

Current Research: Share or Snare? Managing Network Businesses

Academic journal article The McKinsey Quarterly

Current Research: Share or Snare? Managing Network Businesses

Article excerpt

HANS BIESHAAR, MICHEL VAN DE COEVERING, AND PIERRE GIRARDIN

The McKinsey Quarterly, 1996 Number 2, pp. 188-190

There is increasing attention being paid to the economics of networks and the strategies of network-based businesses, both in traditional businesses such as airlines, or in emerging businesses including Internet applications. Three questions emerging from these discussions are: (1) How to proactively and pragmatically manage network-based businesses to capture scale economies while avoiding overcapacity? (2) When to focus on creating value within versus outside the network? and (3) Should the network be open or closed?

PROACTIVE MANAGEMENT

Network-based businesses have to be managed differently from most service and manufacturing ones due to four unique characteristics: the "factory" (that is, the network configuration) determines product parameters; capacity creates demand; operations are integrated; and the "factory" is shared by many products.

In addition, most network-based businesses are very sensitive to scale economies. As illustrated by airlines, both unit costs based on aircraft economics and crew utilization and performance measured by frequency and value of frequent flyer programs, can substantially improve with size throughout volume [ILLUSTRATION FOR EXHIBIT A OMITTED]. However, as many players try to capture these economies, they are likely to destroy industry profits, given that most networks have significant fixed costs and high exit barriers, causing prices to "free-fall" to marginal costs once overcapacity occurs.

Balancing scale advantages against the risks of overcapacity requires a pragmatic approach focusing on three areas:

(1) Understanding product and network economics

(2) Evaluating demand elasticity in terms of price and performance

(3) Taking competitive dynamics into account. …

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