Automating the flow of information among companies is costly and complex. Web services, argues John Hagel, promise to make it cheap and easy.
John Hagel III
The McKinsey Quarterly, 2002 Number 4 Technology
Companies in every sector have streamlined their internal processes by integrating systems and eliminating the manual activities once needed to coordinate the flow of information across the enterprise. Streamlining processes that involve interactions between companies has been more difficult, however: the automated connections that they currently forge with one another can funnel only certain types of information and require negotiations over the value of these expensive connections.
Web services new technologies that spring from the Internet and are used mostly to automate linkages among applications might at last make such connections not only possible but also easy and cheap. Today, connecting systems inside a company (a procurement system and a finance system, say) can require the IT staff to write customized code that “glues” them together. Making connections between companies and their applications exponentially increases the job s complexity and cost. But thanks to the emergence of Web services, programmers can now write a layer of software that sits on top of an application and connects it to any other Web services-friendly application quickly, cheaply, and flexibly.
In the new bookOut of the Box: Strategies for Achieving Profits Today and Growth Tomorrow through Web Services, McKinsey alumnus John Hagel argues that companies will use these technologies first at the “edge” of the enterprise where business activities involve communications and transactions with other organizations, such as trading partners and customers. Companies that had better and cheaper connections with one another could gain cost savings in the short term and look forward in the longer term to collaborating more innovatively to give customers more value.
In the decade ahead, companies will pursue strategic opportunities and performance improvements abetted by a new generation of technologies called Web services. Such companies will adopt this novel approach at the edge of their enterprises, where they bump up against customers, dealers, and suppliers, as well as in activities requiring frequent interaction with any number of people and organizations activities like customer support, marketing, procurement, and sales. As a result, these companies will forge connections among existing systems and applications less expensively and more rapidly and flexibly than they can using today s conventional technologies.
Automating the flow of information between a company and its business partners has always been difficult and expensive. Many interactions thus require human intervention for instance, employees who key into corporate systems the data retrieved from business partners through faxes, telephone calls, or even lists printed out from the systems of other companies a practice that leads to human error. Furthermore, many companies maintain larger stocks of inventory than they really need, because the flow of information among partners in the value chains of most sectors just isn t efficient enough. Since activities near the edge of businesses abound in inefficiency, the opportunities for creating near-term value from Web services are substantial there, which makes it likely that companies will apply them in this way before using them to knit together core internal systems.
Until now, though, integrating the systems of one company with those of its partners has been less feasible than integrating internal systems. Web services promise to change that. Better connections among trading partners are going to mean that companies will be able not only to streamline their edge activities but also to collaborate on improving internal processes, such as product development.
But the real long-term prize of business collaboration lies in mobilizing the assets of partners to deliver more value to their customers. When cooperation among different businesses resembles the activity of a network, they can increasingly focus on innovation in their core activities, and the network becomes more efficient and flexible in what it can offer.
Such process networks are powerful tools for unleashing the potential of specialization.1Emerging Web services technologies will play a crucial role in facilitating them. Companies will find that they can wrest near-term operational savings from edge activities in effect, setting the stage for efforts to pursue the longer-term strategic and operational benefits of collaboration. If these emerging technologies come to fruition and they should companies will use them to cut costs at the edge and, eventually, to reap still greater advantages.
To extract value from these technologies, it will be necessary to make hard business decisions about the way they are used instead of merely treating them as just another new software tool, for their power lies in the ability to make the systems of trading partners interact. Another specific feature of Web services is their ability to let companies start with small, focused initiatives to achieve quick wins at minimal risk and then to build on success as they evolve.
Technologically, every company is an island, operating with its own assortment of systems, applications (some created in-house), databases, and communications technologies. Within a company, the chief information officer can impose hardware and software standards to promote the sharing of data and the common use of applications across the enterprise; such a company might, for example, develop a proprietary forecasting system that feeds data automatically to a procurement application purchased from a software company. Developers then design a customized connection with that application s function in mind. But when, say, six applications must talk to one another, the expense and the effort increase sixfold. Massive enterprise-resource-planning systems can integrate corporate applications, but these projects may cost hundreds of millions of dollars and take several years to implement.
At the edge the frontier of IT connectivity the challenge of integrating systems is even greater. Few companies have the power or t he will to force their trading partners to adopt common systems. Conceivably, a company could replicate in-house the IT platforms used by its most important trading partners and thus enjoy a seamless flow of information, but the effort required would be prohibitively expensive and complicated. It is also conceivable, in theory at least, that all of a company s present and potential trading partners would adopt the same enterprise application suite, but this is basically a science fiction fantasy.
The few connections that companies do make among themselves, largely using electronic-data-interchange (EDI) networks, are of limited use. These networks provide only for the exchange of specific transaction data for instance, invoices and requests for proposals and can t be used to exchange the quantity and quality of information needed for higher-value collaboration, on product development, for example. EDI connections are also expensive and inflexible. As companies forge more and more links, they will find that using EDI to connect new business partners or to shed old ones is neither quick nor cheap.
Early generations of Internet technology didn t solve the problem. People and businesses can connect easily to World Wide Web sites, but to conduct commerce through a Web front end, companies must forge customized connections between the site and numerous enterprise databases, systems, and applications.
A new approach
The advent of Web services promises to let a company connect its applications to any number of trading partners relatively inexpensively and easily. Of course, Web services could also be used to link applications inside the company. But these are experimental technologies and for now most companies will prefer to stick to more expensive but proven and reliable approaches to integrate key internal systems. The best use of Web services currently lies in edge applications, where connectivity problems are more complex, efficiency gains are greater in the near term, and alternative ways of connecting companies are limited.
These evolving technologies are essentially a number of Web-based standards and protocols that enable companies to connect applications and data directly to one another.2The standards can be incorporated in a layer of software (an interface) that companies put atop an existing application, thereby allowing any other application with a similar interface to link up with it and communicate data. Writing this layer of middleware is far less expensive than customized code about $30,000 for a modest connection between two applications, according to one financial-services company, compared with $800,000 for the customized version. Moreover, code rooted in a feature of an application makes for a rigid connection: if the underlying application is changed, the customized connection must also be changed or even rewritten. Web services let companies tinker with the application while avoiding changes to the interface.
What this means for business is that a company like Nike, with many product iterations and a broad range of partners, will be able to connect its own technology to that of its suppliers more efficiently, reducing the need for employees to send, receive, and reenter transaction data manually. Such a company could expand the amount and kind of data it exchanges with trading partners, thus not only improving the way both sides interact and collaborate but also transforming the way they develop, make, and distribute products. By using Web services to enhance collaboration in business alliances, some companies could even expand the value of the goods and services they deliver to customers. In addition, Nike would enjoy greater flexibility, so that when fashions changed the company could add new sup pliers and drop others quickly and inexpensively. Similarly, it would be able to connect more readily to the large and fragmented retailer network that sells its shoes.
Web services also help companies outsource business processes. Whenever a company turns over the management of a process or function manufacturing, logistics, or human-resources management, for instance to an outside provider, that process becomes an edge activity and thus presents the kind of coordination challenge any other such activity involves. Technology companies that outsource manufacturing, for example, must ensure a seamless transfer of data from their product engineers to the providers manufacturing engineers. To help such companies, one manufacturing-services provider is launching a Web services tool that will enable both groups of engineers to start collaborating in the development of new products at an early stage. In initial trials, the company and selected clients managed to cut design-cycle times by more than half and to tackle such time-wasting problems as a 50 percent error rate in bills of materials generated by product-development engineers. By making it possible to identify design enhancements earlier, the collaborative approach also promises to reduce manufacturing costs substantially.
This achievement is just the beginning. Managers should understand that Web services still represent more of a potential boon than a real one. Only a small number of companies, among them Dell Computer, General Motors, and Merrill Lynch, are using Web services protocols to connect selected activities to suppliers, dealers, or customers. Eventually, specialized utilities companies that offer mission-critical managed services, such as security and specialized messaging, that support applications using Web services will be needed to ensure the reliability of these technologies. If collaboration is to work, moreover, companies must define the business terms they share: will product sizes be specified in centimeters or inches, for instance, and defined as a product s height by length by width or in some other way? Without precise definitions, the exchange of information can t be automated.
How quickly these limitations are overcome will determine how quickly Web services can be adopted. Because technology companies, notably IBM, Microsoft, and Oracle, are investing billions of dollars to develop them and because their value to end users is so compelling it makes sense to be optimistic about the outcome.
The next step
Web services won t remain on the edge for long; once companies have enjoyed the short-term advantages of reducing the inefficiencies on their boundaries, they will want to connect the edge to the core and to integrate internal applications. A company that has used Web services to automate, say, its procurement transactions might soon find reasons to tighten the integration of data and activities throughout its broader core manufacturing and logistics process. If older legacy systems that support manufacturing or logistics haven t been integrated or are only partially integrated across the enterprise, Web services can provide improvements and promote flexibility to greater effect than conventional technology.
Dell is one of the companies that have already started to expand their use of Web services from an edge activity (in this case, coordinating business processes across the supply chain) to core activities. In 2000, the company began sending components specifications to its suppliers in a Web services format so that the suppliers inventory-management systems could read the data automatically. That move helped Dell reduce the inventories of components at its many geographically distributed assembly plants by more than 80 percent from 26 to 30 hours of production down to 3 to 5 hours. This was a huge improvement for a company in which direct materials account for 7 0 percent of revenues.
Dell didn t stop there. Its suppliers serve many plants, and the company decided that if it could aggregate information across them, it could match production capacity more efficiently to demand and manage supply shipments accordingly. The snag was that because of the company s rapid growth and geographical expansion, each Dell assembly plant had implemented its own manufacturing applications and database-management systems, with no effort at coordination. Information was thus shared manually. Rather than replace systems to achieve uniformity across plants, Dell used Web services to do the job, vastly improving utilization and cutting logistics costs throughout the production network.
The company used a Web services standard, the Extensible Markup Language (XML), to create a common format for representing data on its inventories and manufacturing operations. Rather than restructure or replace all its existing databases a massive undertaking the company converted the data into the common format by creating a front end to each database. This approach facilitated communication across Dell s manufacturing operations at a much lower cost and served as the basis for automated communication with the company s supply chain partners.
Web services could also integrate edge activities with applications that support administrative functions. Selling, for example, is an edge activity, but if a sales representative works on commission, each transaction must be communicated to the company s human-resources and financial-management applications. Finally, companies might deploy Web services to help integrate systems after a merger or acquisition. Merging companies rarely have the same technology platform, but with Web services they could integrate their disparate systems fairly cheaply and reap the benefits of consolidation more quickly.
How to use Web services today
Investments in Web services, on the one hand, and in conventional technologies, on the other, call for different approaches. Because large critical systems, such as enterprise platforms and supply chain or customer-relationship-management (CRM) applications, are hard to modify once they are in place, companies that implement them must assess the long-term competitive implications of the technology and of the organizational and process-related changes needed to capture the investment s value. By contrast, the flexibility of Web services allows companies to change (and to generate new iterations of) applications that use Web services technologies and the processes they support. A company can thus invest modestly at first, focusing on near-term economic returns, and scale up as Web services mature.
When managers plan their investments in Web services, they should follow three principles leverage existing technology, implement investments in stages, and plug in new elements of the technology over time and carefully balance the longer-term strategic and operational advantages that Web services can support.
Leverage existing technology
When a company installs an enterprise platform, the sensible course is probably to rip out legacy systems and to replace them with applications that run on the new platform. The reverse is true with Web services. Here, the new technology is essentially an overlay, so the challenge is to get more value out of existing assets. Companies should also consider the additional capabilities that Web services alone can provide.
To benefit fully from a large application, a company must generally redesign many of its core systems. With the more mo dest and focused Web services approach, little or no restructuring is needed and an installation can be completed in days or weeks rather than months or years. This means that not only companies but also their trading partners can invest in stages.
During the past two years, for example, Dell has implemented several Web services initiatives in clearly defined stages tied to specific aims, including the reduction of operating costs and inventory. This gradual approach enabled Dell s trading partners to implement their own investments in stages, thus keeping the cost of migration low. The partners had no need to commit themselves across the board to a new technology architecture at the outset; they could edge their way in, gaining experience and motivation as benefits materialized.
Initially, companies can invest in edge activities in which the wins will be quick and tangible. Dell started with simple initiatives, such as compressing its cycle of manufacturing-schedule releases and coordinating its interactions with a limited number of vendor-managed distribution centers. Once it had demonstrated the business impact of these early steps, it moved on to more challenging programs notably, extending its automated connections to include first-tier suppliers.
Plug in new elements over time
The fact that Web services components can be added without redesigning an entire system means that a company can adopt them without having to fear that it will be overtaken by later adopters armed with more advanced technology. Indeed, companies that quickly build the institutional skills (such as the ability to manage relations with partners) that are needed to harness Web services will probably stay ahead of the curve.
Of course, there is a flip side to this virtue: some elements of the Web services architecture are not in place to date, so companies must be realistic about what they can achieve. Their investments should be based on an objective understanding of the current state of these technologies, and they should avoid initiatives that depend on features not yet available. Any company tempted to fill the gaps with older technologies should be wary of creating hybrids that will limit its options when Web services alternatives become available. Proprietary extensions to fill gaps in the features of Web services, for example, should be implemented as modules with clearly defined interfaces. In this way, it will be easier to replace the proprietary extensions with evolving Web services standards as they become available.
One further word of caution: a staged, pragmatic implementation of Web services at the edge of enterprises is by no means without pitfalls. This approach gives managers time to learn about these technologies and to develop insights into the broader operational and strategic possibilities of business collaboration. But executives lulled into complacency by the simple and mundane nature of Web services and by their early tactical implementations might overlook the broader opportunities and lose valuable time. It is management s attitude that will ultimately determine who creates value with Web services.
A new technology architecture that first emerged from the cloud of the Internet will reshape the IT platforms of enterprises and lay the groundwork for entirely new business opportunities. Assertive managers who recognize the potential of this architecture will use it at the edge of their companies to realize profits today and explosive growth tomorrow.
John Hagel, an alumnus of McKinsey s Silicon Valley office, is now an independent Silicon Valley consultant and can be reached athttp://www.johnhagel.com/. This article is adapted from John Hagel III,Out of the Box: Strategies for Achieving Profits Today and Growth Tomorrow through Web Services, Boston, Massachusetts: Harvard Business School Press, 2002. Copyright © 2002 John Hagel III. All rights reserved. Reprinted by permission of Harvard Business School Press.
SeeJohn Seely Brown, Scott Durchslag, and John Hagel III, “Loosening up: How process networks unlock the power of specialization,”The McKinsey Quarterly, 2002 special edition: Risk and resilience, pp. 58 69, as well as John Hagel III, “Leveraged growth: Expanding sales without sacrificing profit,”Harvard Business Review, October 2002, pp. 68 77.
For a more detailed look at what Web services are and how they work,seechapter 2 ofOut of the Box: Strategies for Achieving Profits Today and Growth Tomorrow through Web Services, as well as John Hagel III and John Seely Brown, “Your next IT strategy,”Harvard Business Review, October 2001, pp. 105 13; and Ayman Ismail, Samir Patil, and Suneel Saigal, “When computers learn to talk: A Web services primer,”The McKinsey Quarterly, 2002 special edition: Risk and resilience, pp. 70 7.
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