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 / First Quarter 2001 / Issue 22(originally published by Booz & Company)


The Three Phases of Value Capture: Finding Competitive Advantage in the Information Age

Creating value is just the beginning. To make money from innovation, you must drive your industry's evolution — even before the industry exists.

In 1878, Thomas Edison placed a metal cylinder on a threaded axle, attached a mouthpiece and diaphragm to a stylus, and, while rotating the device, spoke the words "Mary had a little lamb" into the contraption. Translated into waves and engraved on the cylinder, the sound of his voice was returned to him moments later. That sound gave birth to a vast and influential recording industry, from which Edison — an entrepreneur as well as an inventor — profited greatly. The "Wizard of Menlo Park" had created value and captured a large portion of that value for his company.

In 1999, Shawn Fanning, a 19-year-old computer student, created a software program that allowed individual computers to search for and download music from myriad other computers around the world. Almost immediately, Napster, as he called his Internet-based "peer-to-peer" computing program, began to transform the recording industry: Consumers now could record digitized tunes on their own hard drives, entirely free of any type of royalty or other charge.

Shawn Fanning, like Edison, had created untold value for the public; in a little more than a year, Napster attracted 38 million users worldwide, including more than 8 percent of home Internet users in the United States. Yet unlike Edison, he could find no way to capture any of that value for his company. Indeed, by breaching the major record labels' previously sturdy distribution oligopoly, Napster made it increasingly difficult for any single player in the recording industry — whether composer, performer, producer, distributor, or retailer — to capture the value Mr. Fanning unleashed.

Similar stories have played out across the short history of the New Economy. Netscape's version of the Mosaic browser shaped and popularized the World Wide Web; but, unable to directly "monetize" its invention, Netscape sought protection in a merger with America Online Inc. Companies ranging from the venerable New York Times Company to the startup posted their content across the Web, yet the payback from either paid subscriptions or advertising has been at best limited. Indeed, it's becoming clear that for every Dell, Schwab, or Cisco, there are dozens of companies that have been unable to capitalize on their innovations. The evidence can be found in the Nasdaq listings and the drumbeat of dot-com disaster stories in business press. They illustrate the greatest challenge of the New Economy: how to bridge the widening gap between value creation and value capture.

Many companies today are stuck inside that gap. They have seen innovation galvanizing customer interest and propelling revenue growth across an industry — simple measures of value creation. So they have developed Web sites on which to sell their goods and services, built infrastructures for sales and service, and spent millions on marketing, all on the assumption that they could grab some of that customer interest and revenue growth to lift their own profitability — the only valid gauge of value capture. Yet profits have hardly ever materialized.

Why? Because many of these companies did not shift their focus from value creation (revenues) to value capture (profits) soon enough, and instead followed the flawed logic that scale, scope, and increasing returns on incremental investments govern their business. Compare the e-tailers that have chased "eyeballs" into bankruptcy with established retailers like Wal-Mart Stores Inc. and Home Depot Inc. Realizing that retailing does not enjoy increasing returns on incremental investments, they correctly fine-tuned their business models to generate profits after reaching a minimum efficient scale.

Wal-Mart and Home Depot are not alone. All types of companies can still capture value from their own and others' innovations by finding and exploiting new "choke points" — places on a value chain where potential profits reside — that will create competitive advantage.

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  1. Martha Amram and Nalin Kulatilaka, Real Options: Managing Strategic Investment in an Uncertain World, Harvard Business School Press, 1999
  2. W. Brian Arthur, Increasing Returns and Path Dependence in the Economy (Economics, Cognition, and Society), University of Michigan Press, 1994
  3. Clayton M. Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail, Harvard Business School Press, 1997
  4. Adrian J. Slywotzky, Value Migration: How to Think Several Moves Ahead of the Competition, Harvard Business School Press, 1996
  5. Adrian J. Slywotzky, David J. Morrison, and Bob Andelman, The Profit Zone: How Strategic Business Design Will Lead You to Tomorrow’s Profits, Times Books, 1998
  6. Jan Dyer Torsilieri and Chuck Lucier, “Climbing Up the Value Ladder,” s+b, Fourth Quarter 2000; Click here.
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