ferraro 2010 shaping an industry in your favor

8/6/2019 Ferraro 2010 Shaping an Industry in Your Favor

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In 1999, Hilary Rosen, then chie executiveo the Recording Industry Association oAmerica (RIAA), gathered the heads o themajor music labels in the United States

around a table at the Four Seasons Hotel inLos Angeles to discuss what to do about digitalmusic. Instead o rehearsing legal arguments,she simply ased those present to name songs anything rom their latest hits to their baccatalogs and with a computer in ront o her,she proceeded to show them that every singlesong they could thin o was already available

on Napster, the online ile-sharing service.The music executives were stunned and notjust a little worried. What would this mean or

their bottom lines?Ten years later, the music industry is still

in a quandary and their bottom lines are stillshrining, rom $13 billion in sales in 1999 to$8 billion last year. The only thing clear is thatthe traditional distribution model cannot hold,yet large music companies are clinging on, wag-ing an unpopular and ultimately sel-deeatingbattle against illegal downloads. Yes, the RIAAsued Napster and shut it down, but, as manycompanies are learning the hard way, you canwin a battle and still lose the war, especially

when the rules o the battleeld have changedso completely.

In recent interviews, Hilary Rosen has ex-

by fAbriZio fErrAro

Shaping an Industryin Your Favor

LESSONS OF A HOLLYWOOD MOGUL

deepinsight

ieseinsight30 IssuE 4IRsT QuARTER 2010

Thisdocumentisanauthorizedco

forersonaluseofMs.Andreu20/05/2010


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they elt lie MTV was building a business ontheir bacs. You hear a lot o the same ind otal with the success o iTunes. Even though itsputting big paychecs in the record companycoers, theyre still upset that its got so muchpower over them.

So what should RIAA members have done?What should any business leader do when the whole architecture o their industry is sud-denly up or grabs? When all the players areexperimenting with vastly dierent roles, andthe distribution o value across players is arrom being settled, the ey may be to become

the bottlenec in the chain, thereby eepingmore o any value created. A novel industry ar-chitecture, as we shall explore in this article, isnot necessarily a bad thing i you can succeedin reshaping it to your advantage.

th Conc of inuryArchcurTechnological and regulatory changes havebeen shown to have a dramatic impact on thestructure o industries and their competitivedynamics. Consider how the digital era is re-

shaping the music industry, or how prooundlyderegulation has changed the telecommunica-tions sector. However, the specic shape thatindustries tae is not purely determined bythese exogenous shocs, but is inuenced bythe decisions that managers mae in responseto these shocs.

The concept o industry architecture asproposed by Michael G. Jacobides might helpmanagers ace these challenges. An industryarchitecture essentially consists o (1) a tem-plate dening how labor is divided, and value

created, in the industry who does what; and(2) a template deining value appropriationand division o surplus who gets what. Thesetemplates dene the roles and rules ollowed ina specic industry, and they are reinorced bytechnological or institutional actors. Techno-logical standards, or instance, might requiretwo companies to collaborate in a productionprocess, which ends up dening their respec-tive roles in the value chain. Liewise, strongregulatory or social norms about what is ex-pected o an actor may contribute toward de-ning the division o labor between rms and

the distribution o prots.Industry architecture, thereore, both con-

strains the action o competitors by dening

pressed regret over Napsters demise, seeing itas a lost opportunity: the industry was too slowto tae advantage o it, to embrace it, and nownew entrants, such as Apple, are taing a leadingrole in the industry by providing a user-riendlyplatorm or legally downloading copyrightedmaterial. Other players are experimenting withradically dierent business models, such asree ad-supported music (MySpace, YouTube,Imeem), music-as-service (Rhapsody) or a mixo the two (Spotiy).

Regardless o which dominant modelemerges, the traditional music labels are now

in a much tougher position. According to TimQuir, vice president o music programmingor Rhapsody, they only have themselves toblame. In an NPR interview in October 2009,he described it this way: They now what theircatalog was worth in the past. They now whatits worth today. They do not now what its u-ture value will be, so their job is to maximize itspresent-day value. The big ear is not so mucha loss o money as a loss o control. MTV wasa huge success. Labels still hate MTV because

in 1939, at the age of 26,

le wasserman arrived in

Lo Angele with the talent

agency MCA. Over the next

three decade, he took MCA

rom a peripheral player to

becoming the dominant tdio

in Hollywood. How did an

otider manage to change the

competitive landcape o the

entire moviemaking indtry

o completely? A tdy o thi

acinating hitorical accont

reveal the proce by which a

frm can achieve architectral

advantage.

Manager may be amiliar

with the idea that hock

broght on by technologi-

cal and reglatory change

can trigger the emergence o

novel indtry trctre. The

Waerman cae how therei more to it than that. An in-

novative bine model, by

itel, i not fcient. Rather,

the acqiition o mipriced re-

orce by newcomer and the

incmbent (in)action are alo

critical or newcomer to enter

the indtry, redraw it bond-

arie and achieve architectral

advantage.

Are there opportnitie

or yor company to poition

itel in egment that wold

pt it in the dominant poition?

Waerman experience in

the movie and televiion bi-

ne, a well a other timely

example drawn rom mic

and pblihing, provide el

inight or manager operating

in indtrie with ntable, con-

teted architectre; entrepre-

nerial frm trying to develop

architectral advantage in an

emerging indtry; and ventrecapitalit trying to identiy

invetment opportnitie.

executivesummary

ieseinsight 31IssuE 4 IRsT QuARTER 2010




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ormal and inormal rules or competition androles or interactions, and provides opportu-nity or entrepreneurial players to build a moreavorable competitive position, when environ-mental shocs create an opportunity to renego-tiate them.

This article attempts to address such ques-tions surrounding emerging architecturaladvantage by analyzing the historical case oLew Wasserman. From 1939 until 1965, LewWasserman and his company, Music Corpo-ration o America (MCA), managed to changethe competitive landscape o the motion pic-

ture industry in the United States completely.They exploited technological and regulatorychanges and wielded enormous inuence untilthe 1980s.

th R of Lw WarmanAt the time o his death in 2002, Lew Wasser-man was not widely nown outside o the con-nes o the movie industry. Despite being themost powerul movie mogul in Hollywood anda powerul player in national politics, very littlehad been written on him. Since his death, three

biographies have been published, but much othe attention has been on his inuence in Wash-ington, D.C., especially since the 1960s, ratherthan on his role as a business strategist.

Nevertheless, during the rst three decades

Fabrzo Ferraro i aociate

proeor o strategic Manage-

ment at IEsE Bine school.

He hold a Ph.D. in Manage-

ment rom stanord univerity.

At IEsE, he teache clae

on competitive trategy and

trategic deciion-making,

ocing on trategy exection.

He ha alo taght exective

program and/or conlted

with frm ch a Oracle,

Goodyear, General Motor,

Banco santander, Henkel,

Netl, Pig, Gonzlez Bya

and many high-tech tart-p.

He i athor o many aca-demic article on the topic

o el-lflling prophecie,

governance regime, open-

orce otware commnitie

and indtrie in tranition. Hi

reearch ha been pblihed

in theAcademy o Manage-

ment Review (2006 Bet Paper

Award),Academy o Manage-

ment Journal and Organization

Science. He i aociate editor

o the European Management

Review. Prior to entering

academia, he onded Inter-

active Market Reearch, an

international market reearch

frm. He i now exploring the

development o the ocially

reponible inveting feld, andthe role that fnancial model

and tool play in the proce.

abouttheauthor

o his career, rom 1939 until the mid-1960s,Wasserman reshaped the motion picture in-dustry in the United States and too MCArom a peripheral player in the talent-agencybusiness to becoming the dominant studio inHollywood. As Jac Valenti, the long-reigningpresident o the Motion Picture Association oAmerica (MPAA), once put it: I Hollywoodwas Mount Olympus, Lew Wasserman is Zeus.

In 1936, at the age o 23, Wasserman joinedMCA, which was a successul band-booingagency based in Chicago. Three years later, hemoved to Los Angeles to help Jules Stein, MCAs

ounder and president, build up the movie sideo the business. At the time, the movie indus-try was vertically integrated, and most actors,directors and writers were salaried employeeso the studios, typically under seven-year con-tracts. Given this situation, an agency lie MCAcould help these talents brea their studio con-tracts and negotiate better ones with other stu-dios on a project-by-project basis. MCA startedacquiring stars contracts.

The established Hollywood players, suchas the Selznics, William Morris and Famous

Artists Agency, did not see the opportunitiesto be had. They remained ocused on signingnew talent or radio, vaudeville acts, clubs andtheater, which they regarded as more lucra-tive businesses, given that the studios tradi-tionally strong position in Hollywood seemedsewn up. As Wasserman noted, They elt theydidnt need to (buy stars contracts), they wereings () it was beneath them. Given this, theincumbents were more than happy to see thisbusiness going to MCA. Only ater MCA hadproven that representing movie talent could

be truly protable did the other players taenotice. But by then, MCA had consolidated itsposition.

Two disruptive changes in the movie indus-try created the opportunity or Wasserman toprot rom the investment that MCA was ma-ing in talent: the 1948 Paramount decree andthe rise o television.1.aregulatory shiftgivesrise to innovative

practices. During the so-called Studio Era othe 1930s and 40s, most o the talent, as wellas the nancing, production and distributiono movies, was controlled by ve major studios:

MGM, Paramount, Fox, Warner Brothers andRkO Radio Pictures. Most importantly, thesestudios owned practically all the theater chains





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across the country in which to show their lms.This put independent theater owners at a majordisadvantage: They needed to operate at ull ca-pacity just to stay aoat, but the only way theycould obtain popular eatures was by entering

into contractual relationships with the majors.The studios too advantage o the indepen-dents limited bargaining power, orcing themto accept movies in blocs without being ableto screen them in advance. In this way, crowd-pleasers were bundled together with substan-dard B-movies, ensuring that even the mostdubious o studio output ound an audiencesomewhere. This vertically integrated architec-ture enabled the studios to exploit all o theirresources ully.

But, as oten happens in business, this gravy

train was about to hit the end o the line. TheU.S. Department o Justice began investigat-ing the industrys oligarchic practices, issuingstern warnings against the unsustainable prac-tices that were holding everyone hostage to vebig players. This eventually led to a landmarcase, United States v. Paramount Pictures, Inc.,in which the U.S. Supreme Court ruled that theexisting arrangement was in violation o anti-trust regulations. The 1948 Paramount decisionorced exhibition to be separated rom produc-tion and distribution. The ve majors were or-

dered to divest their theater holdings.This decision broe the stranglehold o thestudios, giving independents more controlover their own operations. Since the studioscouldnt control the production and exhibi-tion channels anymore, they had no choice butto slash their output by hal. The studios had tolet go o their talent, and the decade ollowingthis ruling witnessed dramatic cutbacs, withthe number o actors under contract with majorstudios going rom 804 to 164; directors, rom99 to 24; producers, rom 149 to 50; and writers,rom 91 to 47.

Enter Lew Wasserman, whose slow andsteady practice o courting talent early on land-ed MCA in pole position. Wasserman did not

just reap the benet rom his control o talent;he also introduced two innovations that wouldreshape the entire industry: prot sharing andpacaging.

Prot sharing or talent had been done in

the past, but it is only with Wasserman that thepractice too o and became institutionalizedacross the industry. The practice helped MCAstrengthen its relationship with the talent, andtoo advantage o the studios concern withcosts, and their need or stars, by sharing box-ofce riss and rewards with them.

In addition to the diusion o prot-shar-ing contracts, MCA also began pacaging thescriptwriters, directors, stars, producers andother talent or movie productions. MCA hadno control over the actual movies, nor did it

have any nancial stae in the nished prod-ucts. But pacaging acilitated the shit in lm-maing authority, especially the initiation anddevelopment o movie projects, away rom thestudios and into the hands o individual lm-maers.

Pacaging and proit sharing became thebuilding blocs o a novel industry architec-ture in which studios were now ocused on thenancing and distribution o movies. Indepen-dent producers, and occasionally talent agen-cies, were producing pictures, oten renting

the studios acilities, and talent agencies weremuch more central in the ow o exchanges,given their control o creative talent. The emer-gence o this new architecture was in responseto an exogenous environmental shoc: the Par-amount decree and the studios loss o controlover exhibition. Nevertheless, this congura-tion o actors and activities was not a naturalconsequence o these shocs, but rather theemergent outcome o the interacting players.

The introduction o two novel practicesenabled the shits in roles that the players ex-perienced, and later reinorced these new rules

o the game. Wasserman played a critical partin this architectural shit by introducing thenovel practices and, given his control o the

Profit sharing for talent had been done in the past,but it is only with Wasserman that the practice tookoff and became institutionalized across the industry.





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creative talent, reaped most o the benets. Inthis sense, it is air to say that Wasserman re-shaped the industrys architecture to become

its bottlenec.2.the adventofnew mediacreates space fornewcomers. The rise o television provided an-other opportunity or Wasserman. By 1950, 25percent o American households owned a TVset, and within two years, that penetration ratehad doubled. Alongside this, between 1949 and1953, movie attendance decreased consider-ably.

Recognizing that television posed new com-petition, the studios attempted to address thisthreat in various ways. First, they tried to con-trol TV broadcasting, but the Federal Commu-

nications Commission (FCC) bloced movesin this direction. Then, they invested in maingthe moviegoing experience more unique, intro-

ducing enhancements such as CinemaScopeand 3-D. Finally, they tried to starve televisionby not sharing their ilmed content with the

networs.In interpreting the opportunities oeredby the new technology, studio executives werebound by the traditional studio logic, whichwas based on direct control o distribution andexhibition. In viewing television through thislens, they were trying to get bac what the Para-mount decree had taen away.

Disillusioned by the ailure o their eortsto control the T V industry, the studios becameantagonistic toward the medium. This led to astubborn reusal to provide content. Jac War-ner, in particular, amously declared in 1950

that the only screens which will carry WarnerBrothers products will be the screens o motionpicture theaters the world over. In act, none

Are incumbents actions constrained

by strong industry norms and

institutional logics?

Is the coming environmental shock likely

to increase the value of your assets and of your

business model?

There is a good opportunity for you to reshape the industry architecture in your favor.

Low chance

of developing

architectural

advantage.

Business Model

Assets

Industry Norms

Technology & Regulation

New Industry Architecture

Can you reorganize the flow of activity in the

industry in ways that help you leverage your

investment in those assets, and thereby become

the bottleneck of the industry?

Reshaping Industry

ArchitectureACHIEVING A BLOCKBUSTER RECONFIGURATION

LIKE WASSERMAN REQUIRES SEIZING

OPPORTUNITIES AS THEY ARISE.

FIGURE 1

2

1

3

4

5

N OY E S

Can you acquire assets which are not critical

to the old architecture, but that might

appreciate?





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Invest in assets at a time when others do not yetperceive them as valuable. And be quick to introducenovel practices when the value of those assets goes up.

o the majors released any o their major worson television until the 1960s.

Hence, most TV programs were produced by New Yor-based advertising agencies. Asthese agencies were already producing pro-

grams or radio on behal o clients such asProcter & Gamble, Texaco and Chrysler, they were naturally irst in line to translate thisready-made production model to television.But the networs grew restless over their in-ability to control production and scheduling,so they began exploring alternatives.

Eventually, the president o the NBC net- wor decided it was high time to wrest pro-gram control away rom advertisers, who wouldonly be allowed to buy time slots or commer-cial breas rather than entire programs. Once

again, MCA stepped orward, happily willing tooer a complete pacage or the TV networs,the same way it was doing or the studios by de-livering scriptwriters, directors, stars, produc-ers and other talent. Networs, such as NBC,which needed content and could not count onmuch cooperation rom the studios, were alltoo happy to buy the whole pacage.

MCA set up a subsidiary, Revue Produc-tions, speciically or television. In a smartmove, it changed the commissioning structure:Instead o charging the usual 10 percent on the

earnings o its clients, MCA charged a pacag-ing ee o 10 percent o the entire productionbudget. By charging or the whole rather thaneach part, MCA was able to leverage its rostero talent much more protably, because it couldnow throw in lesser-nown actors as part o theoverall mix, generating more wor opportuni-ties or an ever-expanding pool o talent.

MCA was now, de acto, more o a produc-tion company than a talent agency, a meta-morphosis that was made complete with theacquisition o Universal in 1962. Though Was-sermann ended up dropping the talent-agency

side o the business, he ept Universal, whichbecame a leading producer o prime-time TVshows and made-or-television movies. Thans

to the steady stream o revenues coming romits television division, MCA-Universal was ableto pour greater investment into eature lms,giving rise to yet another industry innovation the Hollywood blocbuster epitomized byJaws in 1975, which set the bar or decades tocome.

Rhang inury ArchcurSo what can we learn rom this story? How didLew Wasserman manage to reshape the archi-tecture o his industry, and how might we do thesame in ours? As is oten the case, success de-pends as much on your own actions as on yourcompetitors strategies.

The rst lesson is to invest in assets at a timewhen others do not yet perceive them as valu-

able. Thats exactly what Wasserman did withthe wealth o available talent he saw around him a ready resource just waiting to be tapped. Andwhen the value o that talent in his possessionsuddenly soared, he was quic to introducenovel business models to capture more valuerom those assets.

Still, such actions, by themselves, wouldnot have been enough to secure architecturaladvantage had it not also been or the actions,or inaction, o the incumbent players, who cre-ated additional opportunities or Wasserman.

Which begs the question: Why would competi-tors nowingly create a vacuum, just leaving thepath wide open or someone else to step in andll the void?

When we see industry incumbents ailingto seize the obvious opportunities presentedby new technology, or example, its all too easyto dismiss them as being stupid or shortsighted.But this is unliely the case. Most research onthe movie industry shows that the studios didunderstand the challenges that both regulatoryintervention and the rise o television posed totheir industry, and they did set out to address

those challenges in their own ashion.The problem was that their thining was

constrained by the dominant competitive logic





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o the day: that the most protable way o orga-nizing the industry was in vertically integratedrms which controlled exhibition. Indeed, theprolonged success o the studio model up untilthat time had merely served to reinorce theirbelie that this was the only way in which a stu-dio could be protable, so any actions taenwere based on this supposed gospel.

When the Paramount decree broe thisarchitecture, the studios ocused on less risysegments o the chain, and in so doing, divestedassets that did not seem valuable to them anylonger. Liewise, they saw in television another

opportunity to control, once again, the exhibi-tion o their content to restore the old orderthat was sae and amiliar to them. Their ac-tions were not, thereore, stupid or short-sight-ed, but rather, prudent and aimed at reducingbusiness ris in the only way they new how: bycontrolling the ull value chain. We see some othese same logics being repeated today in a va-riety o business sectors in attempting to dealwith the global economic crisis.

Managers are already amiliar with the ideathat industries are characterized by dierent

structural eatures, such as their level o con-centration and the existence o barrier to en-try, and that these characteristics aect theirstrategic options. The Wasserman case showsus that there is more to it than that, related toindustry architecture. As yoursel:n What are the rules and roles that govern your

industry, which are aected not only by tech-nological and economic actors, but also bysocial norms and institutional logics?

n How might new technologies or regulationsdisrupt or brea the rules o the game?

nI you are the industry incumbent, are youractions or reactions unwittingly creatingspace or newcomers?

n Are there mispriced resources that standto gain rom an environmental shoc overwhich you could potentially acquire control?

n How might you redene these rules and ex-periment with new roles that you can playunder a new architecture?

n Can you identiy novel business models thatmight help you become the bottlenec o theindustry, by leveraging the assets you con-trol?

The emerging architecture that Wassermanintroduced was based on ull control o one as-set and one stage o the chain, as well as on two

novel business models that helped everybody inthe industry share ris. Through prot sharing,Wasserman made it easier or studios to rely onthe services o a smaller number o proven starswithout the burden o their cost. With pacag-ing, content-starved TV networs could oer better programming and reduce their depen-dency on advertising agencies, while enablingWasserman to use his stable o talent at ull ca-pacity. Over time, these practices became thecornerstone o the new institutional logic o theindustry.

Currn Archcural BalWorh FghngI started this article by taling about the musicindustry, whose ight to control its industryarchitecture bears more than a passing resem-blance to what occurred in the movie industryhal a century ago. Indeed, there are currentlynumerous industries experiencing major tech-nological or regulatory changes, which mightprovide opportunity or architectural recon-guration along the lines o what Wassermansucceeded in doing.

The legal battle surrounding the GoogleBoos initiative is another case in point. When,in 2004, Google started digitizing boos in part-nership with a number o university libraries inthe United States, the publishing industrysrst reaction was to try to stop Google romproviding ree Web access to copyrighted mate-rial, so they led class-action lawsuits in 2005.

A settlement was nally reached at the endo 2008, which enables authors and publish-ers whose boos are still under copyright to becompensated, and creates a revenue-sharing

ramewor that might reshape the publishingindustry architecture, with Google having apreeminent seat at the table.

Meanwhile, rival companies such as Micro-sot, Amazon, Yahoo and Sony, as well as Euro-pean governments, have ormed an unliely co-alition called the Open Boo Alliance. Theyreghting bac on antitrust grounds, arguing thatGoogles boo settlement is the modern equiv-alent o the 19th century South ImprovementCompany scheme, when the railroads colludedto x prices and concentrate power in the handso John D. Roceeller.

I Google succeeds, it might be able to le-verage its dominant position in Web searches,which hovered around 65-70 percent o U.S.





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toknowmore

n abrizio, ., and K. Gre. Bilding Architectr-

al Advantage in the u.s. Motion Pictre Indtry:

Lew Waerman and the Mic Corporation

o America. European Management Review 6

(2009): 233-249.

n Jacobide, M.G., T. Knden and M. Agier.

Benefting rom Innovation: Vale Creation,

Vale Appropriation and the Role o Indtry

Architectre. Research Policy 35, no. 8 (2006):

1,200-1,221.

n Brck, C. When Hollywood Had a King: The Reign

o Lew Wasserman, Who Leveraged Talent Into

Power and Infuence. New York: Random Hoe

Trade Paperback, 2004.

maret share throughout 2009, to becomea central player in the distribution o digitalboos.

Whatever the outcome, its obvious that,thans to the acquisition o an asset that pub-

lishers did not seem to appreciate out-o-print and public domain boos Google mightbe able to consolidate a strong position in theindustry.

In another ield, the digital revolution inthe newspaper industry is pushing more news-papers to outsource the production o content.Much creative talent is being liberated towor as reelancers. Could these resources thatnewspapers are letting go be leveraged moreprotably by entrepreneurial players under anew industry architecture?

ingh for ManagrThe Wasserman story highlights two ey in-sights o relevance to managers operating in in-dustries with unstable, contested architectures,and entrepreneurial rms trying to develop ar-chitectural advantage in an emerging industry.

First, opportunities or entrepreneurialaction are generated, not just by incumbentsattempts to cope with environmental jolts,but when the dominant logics o the industry,together with other regulatory and institu-

tional arrangements, eectively limit the in-dustry players range o options. This createsopportunities or nimble players who are notconstrained by the same logics. Furthermore,the actions o the incumbents might actuallyaccelerate the change in architecture by sell-ing assets that the newcomers might leveragemore efciently in the novel architecture theyare building.

Second, in designing, championing and in-stitutionalizing innovative business models,the new entrants in a speciic segment o anindustry can stimulate competition in adjacent

segments and consolidate their control overcritical resources. This control can be achievednot only through technological design choices,

but also rom more mundane contractual recon-gurations o the industrys exchanges.

Thus, merely coming up with an innova-tive business model is not enough to triggera change in the architecture o your industry.

The acquisition o mispriced resources bynewcomers and the incumbents (in)actionare also critical or newcomers to enter theindustry, redraw its boundaries and achievearchitectural advantage.

Managers operating in industries with un-stable, contested architectures, and entrepre-neurial irms trying to develop architecturaladvantage in an emerging industry, could lever-age these insights by asing themselves whetherincumbents reactions to environmental shocsare creating investment opportunities or them.

Venture capitalists trying to identiy investmentopportunities might examine the role o theoverlap between organizational elds, and ocustheir eorts in industries where more logics in-tersect, because we would expect more innova-tive business models to emerge and, thereore,more opportunities to recongure the industryand develop an architectural advantage.

Opportunities are generated when the dominant logicsof the industry, and other regulatory and institutionalarrangements, limit the range of options.




ferraro 2010 shaping an industry in your favor

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