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The Virtual Corporation


Cover Story

THE VIRTUAL CORPORATION

You know the problems. They're the stuff of Management 101. If you run a big, complex company, you battle every day to get things done faster. If you're at the top of a small one, you often struggle to find the resources to make a difference.

In today's world of fast-moving global markets and fierce competition, the windows of opportunity are often frustratingly brief. Few companies boast the in-house expertise to quickly launch diverse and complex products in different markets.

Ever hear of the virtual corporation? Before you roll your eyes, think again. In the view of many leading business thinkers, what sounds like just another bit of management-consultant cyberspeak could well be the model for the American business organization in the years ahead.

The virtual corporation is a temporary network of independent companies--suppliers, customers, even erstwhile rivals--linked by information technology to share skills, costs, and access to one another's markets. It will have neither central office nor organization chart. It will have no hierarchy, no vertical integration.

Instead, proponents say this new, evolving corporate model will be fluid and flexible--a group of collaborators that quickly unite to exploit a specific opportunity. Once the opportunity is met, the venture will, more often than not, disband. "It's not just a good idea," says Gerald Ross, co-founder of Change Lab International, a consulting firm in Greenwich, Conn. "It's inevitable."

TIME STRETCHER. In the concept's purest form, each company that links up with others to create a virtual corporation will be stripped to its essence. It will contribute only what it regards as its "core competencies," the buzz phrase for the key capabilities of a company. It will mix and match what it does best with the best of other companies and entrepreneurs.

A manufacturer will manufacture, while relying on a product-design outfit to decide what to make and on a marketing company to sell it. "Most companies put undue emphasis on owning, managing, and controlling every activity," says Richard C. Marcus, the former chief executive of retailer Neiman Marcus, who is now a partner in a consulting firm that models itself along virtual-corporation lines. "If something was worth doing, you did it yourself. But there's just not enough time in the day to manage everything anymore."

For proof that many companies are starting to feel the same way, look to the growing number of strategic alliances. American Telephone & Telegraph Co. used Japan's Marubeni Trading Co. to link up with Matsushita Electric Industrial Co. to jump-start the production of its Safari notebook computer, designed by Henry Dreyfuss Associates. MCI Communications Corp. uses partnerships with as many as 100 companies to win major contracts with large customers. IBM, Apple Computer, and Motorola are using an interfirm alliance to develop an operating system and microprocessor for a new generation of computers.

EARLY GLIMPSE. Partnering--the key attribute of the virtual corporation--will assume even greater importance, says James R. Houghton, chairman of Corning Inc. Corning may be the most successful U. S. company at putting together alliances. Its 19 partnerships, accounting for nearly 13% of earnings last year, have let the company develop and sell new products faster, providing size and power without the bulk. "More companies are waking up to the fact that alliances are critical to the future," Houghton says. "Technologies are changing so fast that nobody can do it all alone anymore."

But today's joint ventures are little more than an early glimpse of the highly adaptable, opportunistic structure of the future. "When we talk about virtual corporations today, we're mainly talking about alliances and outsourcing agreements," says John Sculley, chairman of Apple Computer Inc. "Ten or 20 years from now, you'll see an explosion of entrepreneurial industries and companies that will essentially form the real virtual corporations. Tens of thousands of virtual organizations may come out of this."

The virtual corporation may now exist mainly in the imaginations of a few business thinkers and theorists (page 41), but similar structures have long characterized several industries. In businesses as diverse as movie making and construction, companies have come together for years for specific projects, only to dissolve once the task is done. The leveraged-buyout firm of Kohlberg Kravis Roberts & Co. forms virtual-style combinations when it assembles lawyers, accountants, and investment bankers to do a specific deal.

What's different now is that large corporations have begun using elements of the virtual concept to gain access to new markets or technologies. Apple Computer's long-standing strategy of partnering is a key reason the company's revenues per employee, at $437,100, are nearly four times those of competitor Digital Equipment Corp. and more than twice those of IBM. Lacking the capacity to produce its entire line of PowerBook notebooks, for example, Apple turned to Sony Corp. in 1991 to manufacture the least-expensive version. It was an obvious pairing, melding Apple's easy-to-use software with Sony's manufacturing skills in miniaturization. A yearlater, after selling more than 100,000Sony-made models, Apple ended its agreement.

The linkage served its purpose: to get an entry-level product out swiftly. Similarly, a small company, TelePad Corp. of Reston, Va., is using collaborations with more than two dozen partners and suppliers to bring its new pen-based computer to market.

If it becomes widespread, the virtual model could become the most important organizational innovation since the 1920s. That was when Pierre S. Du Pont and Alfred P. Sloan developed the principle of decentralization to organize giant, complex corporations. Even the spate of corporate downsizings in the past decade has failed to break the vertical chains of command typical in most large companies. Massive layoffs of middle managers have led to fewer layers of management but have left essentially the same organizational structures.

SUPERHIGHWAY. Already, though, joint ventures and strategic alliances are blurring the traditional hierarchies and boundaries that characterize this largely obsolete model. Customers are helping to create and develop new products and services. Competitors are embracing one another to enter new markets or make products they can't produce on their own. "It's a way to gain scale without mass," says David Nadler, founder of New York-based Delta Consulting Group Inc. Ultimately, these greater levels of cooperation among competitors, suppliers, and customers will create so much overlap that it will be tough to determine where any one company ends and another begins.

Technology will play a central role in the development of the virtual corporation. Roger N. Nagel, operations director for Lehigh University's Iacocca Institute, envisions a world in which technology could make the creation of virtual enterprises "as straightforward as connecting components for a home audio and video system by different manufacturers." He foresees a national information infrastructure linking computers and machine tools across the U. S. This communications superhighway would permit far-flung units of different companies to quickly locate suppliers, designers, and manufacturers through an information clearinghouse. Once connected, they would sign "electronic contracts" to speed linkups without legal headaches.

Teams of people in different companies would routinely work together, concurrently rather than sequentially, via computer networks in real time. Artificial-intelligence systems and sensing devices would connect engineers directly to facture, while relying on a product-design outfit to decide what to make and on a marketing company to sell it. "Most companies put undue emphasis on owning, managing, and controlling every activity," says Richard C. Marcus, the former chief executive of retailer Neiman Marcus, who is now a partner in a consulting firm that models itself along virtual-corporation lines. "If something was worth doing, you did it yourself. But there's just not enough time in the day to manage everything anymore."

If power and flexibility are the obvious benefits of the virtual corporation, the model has some real risks, too. For starters, a company joining such a network loses control of the functions it cedes to its partners--who may drop the ball. Proprietary information or technology may escape. And the structure will pose stiff new challenges for managers, who must learn to build trust with outsiders and manage beyond their own walls.

Still others are wary of the concept because it conjures up the idea of the hollow corporation, the term coined to describe companies that have bolstered profits by abandoning manufacturing and outsourcing production to plants in low-wage countries. Much of the thinking about the virtual corporation, however, comes from experts at the Iacocca Institute who have examined the decline of U. S. manufacturing. They believe the idea--coupled with computer-aided design and flexible manufacturing--could keep jobs in the U. S. In their view, rapidly formed virtual corporations composed of the best of everything will have the competitive advantage.

'ROBUST.' A growing number of company chiefs agree. One is James C. Morgan, chief executive of Applied Materials Inc., which makes the equipment to manufacture semiconductors. Applied's success is based on a collaborative web of suppliers and customers. Each partner specializes in doing part of a system very well, so Applied doesn't have to do everything well. "It's easier to manage a bigger business if others are managing pieces for you," explains Morgan.

Many large corporations are using the virtual concept to broaden their offerings to customers or produce sophisticated products less expensively. MCI, the long-distance telephone company, has allied itself with an array of partners to offer customers "one-stop shopping" for all their communications needs, including helping customers finance their equipment purchases. "Our partnerships make us a more efficient competitor with a more robust set of product offerings," says Daniel F. Akerson, MCI's president.

A central part of MCI's strategy is to match its core competencies in network integration and software development with the strengths of other companies making telecommunications equipment. The upshot: MCI doesn't have to spend its own capital to fund research and development for hardware, leaving more resources for what it does best. MCI's alliances allow it to offer customers a package of hardware and services based on the talents, skills, and resources of as many as 100 other companies. "If we had to do it on our own, it would cost us at least $300 million to $500 million a year in extra expenses," says Akerson.

The virtual concept is also providing muscle and reach for some smaller companies and entrepreneurs. Among its most vocal advocates is Ron Oklewicz, a veteran of Xerox Corp. and Apple Computer who had an idea for a handheld, pen-based computer. Two years ago, he launched TelePad, which has limited in-house design talent, a handful of engineers, and no manufacturing plants. The computer was designed and co-developed with GVO Inc., a prominent industrial-design company in Palo Alto, Calif. An Intel Corp. swat team was brought in to work out some engineering kinks.

Several other companies have developed software for the product. A battery maker is collaborating with TelePad to develop the portable power supply. And to manufacture the computer, the company is using spare capacity at an IBM plant in Charlotte, N. C. The paychecks for its 14 employees are issued by an outside firm, Automatic Data Processing Inc. For his part, Oklewicz brings his experience in selling computers to the government, a key potential customer of the product.

His virtual organization avoids what Oklewicz calls the "vertical rat hole"--the inefficiencies and costs of vertical integration--and seizes advantage of the best efforts of world-class partners to bring his product to market faster. Through more than two dozen collaborations, Oklewicz figures he is leveraging his puny work force into more than a thousand highly trained staffers in design, engineering, manufacturing, and distribution. That Intel engineering team, for example, took only one week to solve problems Oklewicz believes his company would have spent as long as five months on. "We couldn't hire this kind of talent," he says. "The hiring alone would have killed us."

Of course, since TelePad is dependent on so many partners, it has ceded direct control of nearly all its operations. Does that bother the founder? Not at all. "I can go to sleep at night confident that IBM knows how to make this product, rather than worrying whether I made the right capital investments or hired the right people," he says.

The idea has broad implications for service businesses, too. Consider InterSolve Group Inc., a Dallas-based management-consulting firm that consists largely of four partners. For any given assignment, InterSolve assembles "just-in-time" talent to solve problems or implement strategies for clients that range from IBM to First Interstate Bancorp. Once a job is complete, the consulting team disbands. "One of the founding principles of our firm is that we would assemble and disassemble teams for work," says Edward R. McPherson. "We can bring the right talent to fit the assignment as opposed to using talent already in inventory. We don't have to warehouse staff or specialists."

InterSolve's recently completed assignment for First Interstate, for example, saw the creation of four teams of 26 experts led by McPherson, who had met only one of the team members before the assignment. The group squeezed nearly $14 million in annual savings out of First Interstate's back-room operations. "The advantage is you get specialists to work on your problems," says Hayden B. Watson, a senior vice-president at First Interstate. "As long as you keep their activities coordinated, you're going to get a lot more result for the money you spend."

One of the big drawbacks to the virtual corporation is that it spells the loss of control over some operations. A partnership among Intel and Japanese companies NMB Semiconductor and Sharp to make products called flash memory chips shows the potential hazards. Worried that it couldn't make the sizable investments to retain its lead in this important and growing market, Intel signed up the two Japanese companies to make flash chips for it. But NMB Semiconductor Co. had trouble getting its line up and running last year just as the market was taking off.

As a result, Intel couldn't get all the chips it could sell, and its share of the market dropped nearly 20 points in one year. Although he still believes in collaboration, Intel Chairman Andrew S. Grove is no fan of the virtual corpmration. "I think it's a business buzz phrase that's meaningless," he says. "It's appetizing, but you get nothing out of it."

Critics also point to IBM's experience in creating its first personal computer in 1981. To get into the market quickly, the computer giant relied on a pair of outsiders for the key technologies: Intel for microprocessors and Microsoft Corp. for the operating software. At first, IBM won widespread praise for its unprecedented decision to develop a major product by forming partnerships with others outside its corporate walls. But the approach also meant that IBM's system wasn't proprietary, and IBM soon found that it had created a market it could not control. Hundreds of clone makers emerged with lower prices and better products.

The more entangled companies become, the more chances there will be for them to stumble. Besides the technological hurdles of information highways and networks of partners that will make the virtual corporation a reality, the concept poses new challenges for management. Before companies can more routinely engage in collaboration, they must build a high level of trust in each other.

The current clutch of strategic alliances and joint ventures could help here, too, since they give companies a track record of cooperation. "People who think they can screw each other because we're going to terminate six months later are missing the point, because what we're building is a web of trust and shared understandings," says John Seely Brown. Brown heads Xerox' Palo Alto Research Center, which recently developed new products jointly with Sun Microsystems Inc.

WIN-WIN DEALS. The virtual corporation will demand a different set of skills from all managers, proficiencies not unlike those that distinguish the best venture capitalists. They'll have to build relationships, negotiate "win-win" deals, find the right partners with compatible goals and values, and provide the temporary organization with the right balance of freedom and control. That won't be easy. "All of us are comfortable operating in a known environment," says John Vaughan, a divisional vice-president at M/A-Com, an electronic-components maker based in Burlington, Mass., which is joining with AT&T and others to create new products. "All the politics are local, and all the management is personal. But this new model means you have to be more open in dealing with outsiders. To some people, that sounds like fun. To others, it will be hell."

So common will collaborative work become that some gurus are already advocating the creation of a new corporate position. Lehigh's Nagel suggests that companies appoint a "vice-president for external interactions" who would oversee the dozens or hundreds of linkups that he believes will exemplify the organization of tomorrow. Among other things, this corporate officer would monitor the outflow of technology to make sure that the company doesn't inadvertently lose the capability to compete.

A vice-president of virtuality? That would certainly be an irony--corporations may respond to this idea, so antithetical to structure and hierarchy, by creating a new slot for it in their hierarchical structures.A HANDBOOK FOR

VIRTUAL MANAGERS

Today's alliances have taught managers a few key lessons that should help when

the virtual corporation emerges:

MARRY WELL Choose the right partners for the right reasons--because they are

dependable, can be trusted, and offer the best products or services

PLAY FAIR Every link must offer a win-win opportunity for everyone, even if the

outcome isn't always successful. Partnerships must serve the interests of all

parties

OFFER THE BEST AND BRIGHTEST Put your best people into these relationships.

It's the easiest way to tell your partners your link with them is important

DEFINE OBJECTIVES When you ask the question, "what's in it for me?" you

should have a quick and ready answer. Know what you and your partners will be

getting out of the virtual enterprise

BUILD A COMMON INFRASTRUCTURE Until networks and standards let corporations

talk to each other across the street or across the ocean, information systems

must at least communicate with current and potential partners

DATA: BOOZ ALLEN & HAMILTON INC.

John A. Byrne in New York, with Richard Brandt in San Francisco, Otis Port in New York, and bureau reports


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