Energy markets are not alone in experiencing atomization. Defined as the disintegration of an industry chain into ever smaller segments and niches, atomization is also visible in the computer industry, among others.

In computing, the integrated business system represented by traditional players such as IBM and DEC has evolved into a disintegrated form in which specialized challengers like Intel and Microsoft have the advantage. And as disintegration gives way to atomization, hundreds of even more narrowly focused competitors are emerging (Exhibit A).

What is bringing about this transformation? Broadly speaking, it is those features of an evolving market or industry that boost efficiency and allow smaller, more focused challengers to emerge and thrive. Examples include the opening up of industry standards, the growth of spot markets, the emergence of business webs, and the advent of sophisticated financial instruments (Exhibit B).

Such developments make it easier for new entrants to bring their innovations to market. Price and capacity forward markets, for example, help to protect challengers from price and volume volatility, providing a form of market "insurance" to hedge business risk. "Fabless" design houses (for example, Cirrus Logic) have locked up long-term fabrication capacity with players like Taiwan Semiconductor Manufacturing. If capacity should become scarce or prohibitively expensive, these design houses, protected by their fabrication contracts, can continue to innovate and produce. Forward price markets have developed mostly in energy, metals, and agricultural commodities to date. In the natural gas market, many small producers have entered into swap arrangements whereby a buyer commits to a certain volume at a fixed price for a number of years. These producers thus eliminate the risk that the cashflow needed to repay debt may fall short. Enron has established a highly successful trading and risk management business by serving this need for risk intermediation in the natural gas market. Interest in developing forward price instruments is beginning to emerge in areas beyond traditional commodities, such as semiconductor chips.

Such innovations enable challengers to obtain equity and debt financing much more quickly and at lower cost than would otherwise be possible, since they reduce risk for capital providers. They also help to level the playing field vis-à-vis incumbents, which are less vulnerable to price and volume volatility thanks to excess cashflows derived from legacy businesses.

However, other aspects of the legacy business systems of vertically integrated market incumbents work in favor of newcomers. These business systems were originally designed to serve the high-value segments that existed in the market when the incumbents first entered (such as governments and large businesses in the case of the computer industry). However, when technology, experience, and scale effects permit price reductions that make it possible to sell more products to more customers, the incumbents usually find that their legacy business systems are unable to address these new segments efficiently or effectively. Meanwhile, new entrant challengers with segment-focused value propositions and the tailored business systems necessary to support them are beginning to create and capture a disproportionate share of industry value (Exhibit C).

Implications for businesses

What does the atomization of markets mean for the players competing in them? The answer depends on whether a company is a challenger or an incumbent. Challengers are advantaged by the atomization process, since they are able to focus intensively on specific micro-segments within the industry chain. Incumbents, on the other hand, are in a position to influence many of the enablers that drive change, such as industry standards and intermediary market liquidity, as they control the current technology and commodity trade. They also possess a stronger brand to leverage both with the end customer and with other business partners.

Strategy

The key strategic decision for an incumbent is when and how to realign its business system to focus on its chosen market segments. ThermoElectron has tackled this decision in a radical way: it continuously atomizes itself by spinning out new businesses. Incumbents can, like ThermoElectron, take the lead in moving toward an atomized business model, or wait, like IBM and DEC, until the market compels them to respond. We believe it is usually better for an incumbent to take the initiative in this process so that it can exert more influence over the way in which the market atomizes and try to capture the most valuable segments.

No matter how successful the incumbent is in its self-atomization, it will never be able to dominate all segments of its industry. Recognizing that it faces a high degree of strategic uncertainty, its best response may be to join forces with the right set of external players in a business web.¹

A business web is a group of companies (perhaps numbering hundreds) within a disintegrated industry value chain that has adopted a set of common standards and agreed on the interface points where distinct, focused value propositions meet. Business webs are usually based not on formal agreements but on a shared vision of economic potential. They confer the benefits of scale on challengers that are individually small, but collectively become large and powerful.

Participants in a web can choose either to shape it or to adapt to it. Typically, challengers are shapers and incumbents adapters. In large part, this is because challengers—the successful ones, at least—have wrestled standards away from incumbents.

Consider Netscape, which created a de facto Internet standard virtually overnight by giving away its browser. This threatened Microsoft’s dominance, since Netscape’s browser technology is independent of any operating system. However, Microsoft recognized the importance of the new standard and made sweeping strategic and organizational changes, quickly catching up with Netscape.

Microsoft initially played the role of adapter in the new webs formed by the Internet atomizers, but has since developed a shaping strategy. It is now creating new business webs that leverage its scale and technologies, for instance, by "Internetizing" its office applications and operating systems.

The other challenge for both incumbents and challengers is to develop "best of breed" capabilities within their chosen segments to help them capture value and carve out a position within a web. Cisco, for example, is strengthening and broadening its capabilities through acquisitions, having completed more than 15 over the past three years.

For an incumbent, increasing its degree of horizontal integration can be desirable even as markets atomize—but only if it can retain a leadership position within the atomized segments it owns. Cisco, Intel, and Microsoft are all strong horizontal players that have managed to pull this off, capturing considerable value in the atomized phase. But even companies with powerful positions need to be constantly aware of the atomization forces at work; for instance, Cisco’s router dominance is under threat from IP switch players such as Ascend and Ipsilon.

Organization

The most difficult challenge an incumbent faces in moving from a consolidated, integrated business system to a more atomized one is organizational. Most organizations have been designed and fine-tuned to fit a specific business system, and this design (along with the learned behaviors that accompany it) is often difficult to change when the business system becomes outdated. Matrix organizations—which tend to lack proper focus, incentives, and decision-making authority for change—exemplify the difficulty of executing in a changing marketplace. Decisions to relinquish certain segments or capture others through acquisition or new internal efforts are difficult to make within the confines of a matrix.

An incumbent would do better to reorganize in a market-centered fashion, with individual business units focused on specific segments. It will then become self-atomized—in other words, organized into numerous entrepreneurial business units that can be individually measured yet still reside in a broader company structure possessing brand and other desirable assets.

Challengers face difficulties of their own in building an organization that can execute their strategy. Unlike incumbents, they are not hindered by large bureaucratic organizations; on the contrary, they tend to be efficiently structured around specific market segments. Rather, challengers need to focus on business development so that they can address their lack of scale and scope by, for example, participating in business webs.

Markets relentlessly search for innovation and efficiency. Both incumbents and challengers are positioned to deliver. Players should "think entrepreneurial," leveraging the concept of self-atomization more effectively to utilize the human capital within their organizations.