Coke’s API and the Outsourcing of Innovation

While he may not have realized it at the time, Asa Griggs Candler helped pioneer the “platform” business model used by thousands of web companies today.  But Chandler wasn’t a tech startup guy, he was the founder of The Coca-Cola Company.

Coke became a platform company almost by accident.  Beginning in 1886, Coke was principally sold to soda fountains and Candler saw little demand for bottled Coke.  Couldn’t you just get a Coke at your local drugstore?  Besides, creating a bottling and distribution operation was expensive, and lower-margin.  The Coca-Cola Company had great margins.  They didn’t even make the Coke that people drank.  They manufactured concentrated Coke syrup and marketed the final product.  It was the pharmacy soda fountains that added carbonated water to Coke’s concentrate to make the drink.

In the late 1890’s, Candler was approached by two Chattanooga businessmen who proposed creating a Coke bottling operation.  Candler signed a contract with the two men, giving them control of Coke bottling for one dollar (Candler never actually collected the dollar).  Whether Candler didn’t see the potential for bottled Coke or was nervous about the risks and costs associated with building a bottling operation in-house, the decision was incredibly beneficial to Coke over the long-term.  Coke was able to focus on its two core competencies while the technology and manufacturing processes required to bottle mass quantities of soda developed in parallel.  Coke benefited massively from the greater volume and distribution that bottlers enabled.

APIs provide a similar function in the programming world.  Platform companies such as Twitter have stuck to developing their core capabilities (their syrup and marketing) while enabling others to innovate around the Twitter APIs.  Basically, it’s a licensing strategy.  As of the Spring, Twitter was generating about 75% of its traffic through third-party clients (its bottlers) utilizing the Twitter APIs.

Apple’s app strategy for iOS is another example.  Apple developed a few core applications (iCal, Safari, Mail, etc.) for the iPhone platform and then enabled the creation of hundreds of thousands of applications via the iOS SDK.  This has enabled Apple to create enormous value for its platform without shouldering the costs of building thousands of applications in-house (which it couldn’t do with the same efficiency and creativity of its developer community anyway).

There are of course benefits and dangers to innovating on top of another company’s platform.  Primarily, there is a hold-up problem with this type of innovation.  For example, Coke could hold its bottlers hostage and force the bottlers to pay higher fees for concentrate.  On the other hand, bottlers could threaten to choke off Coke’s distribution.  The way to solve these hold-up problems and to improve manufacturer-supplier coordination is through vertical integration, and that’s exactly what we have seen from both Coke and Twitter.

Vertical integration allows a company to remove coordination problems and reduce costs by bringing the relevant supplier(s) or partner(s) in-house.  Coke did this by acquiring its North American bottling partner in February 2010.  Twitter did this by acquiring complementary functions such as search (Summize) and mobile (Tweetie).  These acquisitions reduced coordination problems for Twitter, enabling them to accelerate development of their roadmap.   Most importantly, both companies were able to maintain focus while enabling the ancillary innovation that would become critical to their long-term growth.

On a much broader level, the trend of outsourcing corporate R&D to venture-funded companies seems to be accelerating.  Steven Kaplan and Josh Lerner wrote a great paper explaining this trend, noting that venture-backed firms are three times as efficient in generating innovations as corporate research.  Incumbent (and upstart) technology companies can take advantage of this trend by providing entrepreneurs with the tools that accelerate innovation: API’s, open source software, and greater access to data/information.

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  • John Kim

    Great stuff. Love the way you translate technology development strategy. And what an awesome Coke story. How'd you come across that nugget?

  • Adam

    Glad you liked it! Wikipedia…

  • Manfred

    Since end of 2012 Coca-Cola enterprises, indeed, do provide APIs to allow access to their assets and to allow external innovation.