Successful scaling of blockchain consortia through governance
By Kevin Leuthardt and Kalyanam Karthikeyan
It is well established that the successful scaling of business networks requires a reliable governance framework. The collaboration between profit-seeking organisations is exposed to the so-called coopetition paradox, given the need for collaboration between natural competitors in a particular industry.
Blockchain consortia are a textbook example of groups which fall in the spectrum of the coopetition paradox. Blockchain consortia are defined as a group of companies which collaborate on advancing the state of blockchain technology adoption in the industry, establishing industry standards, drafting use cases, developing key infrastructure and also operating commercial blockchain platforms. Since the strategic value of blockchain technology can only be realised through the respective adoption at scale, these consortia are effectively obliged to address this coopetition paradox through collaboration between natural competitors.
Deloitte has found in a survey it published in August 2018 that more than a quarter of the interviewees have already joined one of the 60+ blockchain consortia; another 45% are about to consider an involvement in the course of 2019.
The continued interest in the deployment of enterprise blockchain projects is also supported by the forecast of large, globally spread and customer-centric digital ecosystems (McKinsey) as blockchain technology is expected to be one of many foundational technologies. Such ecosystems are about to transform existing value chains into new multi-faceted business networks. For example, the global mobility ecosystem is expected to generate an annual sales volume of an estimated USD 2 trillion by 2025 (McKinsey).
Although enterprises have committed quite some resources to blockchain projects, recent break-through success stories are rather rare and many projects do not seem to move beyond the ideation or proof-of-concept stage. Overall, it seems that blockchain technology encounters hurdles in moving up from the labs to a technology applied at scale and therefore patience is likely to be further required through 2019.
There is, in particular, some uncertainty about the return on investments into the blockchain technology (besides regulatory concerns). Moreover, since the strategic value of the blockchain networks lies in its scaling, it is also important to consider that an increasing network size correlates positively with an increase in coordination complexity. Hence, for the few high-potential applications in trade finance, insurance, supply chain and mobility services a proper establishment of sustainable governance principles for the deployment of a blockchain consortium is key.
The difficulty in mastering such governance principles can be also seen from the case of the supply chain platform TradeLens which is built on a collaboration model between IBM and Maersk. TradeLens had embarked on its mission in early 2018 to build “an open and neutral supply chain platform poised to transform the [cargo shipping] industry”. Any intellectual property created from this collaboration is owned by the initiating companies. In addition to this, Maersk established an operational subsidiary whereas IBM has dedicated staff working on the collaboration. Other interested participants can access the core platform in exchange for data they originate. With this setup in mind, TradeLens has been criticised for holding on to the IP rights and keeping commercial platform benefits private with the two initiating companies, whilst forcing other network participants to disclose proprietary data to the platform. Such considerations has certainly led to the initial public rejection of the solution by key industry players such CMA CGM and Hapag Lloyd (Update: Both shipping companies have eventually joined TradeLens in May and July 2019 respectively).
The purpose of this article is to contribute to an open discussion regarding the governance of commercial enterprise blockchain ecosystems. In its essence, the article solely focuses on enterprise blockchain applications through consortia structures. We think of enterprise consortia as a fertile sandbox to mature and learn about blockchain technology and networks before transitioning into a fully decentralised and cryptoeconomics-supported world of autonomous organisations.
After a short outline on a potential governance framework, a possible setup of a blockchain consortium operating in the automotive ecosystem is discussed.
A multi-layered governance framework for blockchain consortia
Governance is generally understood as a means encompassing organisational, legal and economic considerations regarding the operation of an organisation (Ziolkowski et al.).
Analysing the governance of blockchain consortia requires the assessment of the anatomy of the distributed ledger application. With respect to this, Michel Rauchs (Cambridge Center for Alternative Finance) has published a well-received conceptual framework on distributed ledger technology systems in Summer 2018. It segregates the anatomy of blockchain applications into three layers:
We think that the above-mentioned conceptual framework acts as an excellent starting point and we would like to base our considerations on such a model:
In reflection of the early investments made by the initiators as well as the incentivisation needs for later-joiners of blockchain consortia, we have deliberately added associated considerations, in particular concerning intellectual property and so-called sweat equity to our framework. Such considerations will be explained in detail in the case study section. However, please feel free to have a look at an earlier contribution regarding the legal aspects of enterprise blockchains: https://bit.ly/2snWiol
Governance for a blockchain consortia in the automotive industry
This section aims at a simplified illustration of the above-referenced governance principles for an enterprise blockchain consortium in the automotive industry. Let’s begin with having a look at how the automotive industry is organised:
In the recent years, automotive industry’s linear value chain made of suppliers, OEMs, suppliers and dealers has been gradually transformed through disruptive forces such as electrification, autonomous driving, mobility and connectivity into a web of different players operating across multiple industries. This turn of the tide has been closely interconnected with the move towards a more consumer-centric business model. All these changes have been eventually accompanied by a power shift in the industry, which formerly used to be controlled by the large automakers with a very limited threat of new entrants and low bargaining powers for the suppliers. By pointing to the examples of Tesla Motors or Uber, it becomes obvious that there has been truly a paradigm shift.
Before diving into the potential design of governance for a model blockchain consortium in the automotive industry, it is imperative that we look into automotive industry’s adoption of blockchain technologies.
A recent study conducted by Deloitte has expressed that almost three quarters of the respondents see a disruptive force behind blockchain technology for the automotive sector. According to IBM, 62% of the interviewed executives assess blockchain technology as a disruptive force for the automotive industry even within the next three years. Although the industry’s efforts have been initiated, many of the activities do not go beyond mere awareness raising, albeit there are a few exceptions.
In terms of suitable blockchain use cases, industry experts remark particular benefits for supply chain (track & trace, distributed manufacturing: https://bit.ly/2SJzzOS), finance (cross-border payments, procurement), as well as for mobility services. Roland Berger, a management consultancy, further lists the following potential use cases for blockchain technology in the automotive industry: secure communication, car e-wallets, streamlined contractual processes and digital identities for vehicles.
Although, there is apparently a general consensus across the industry about the potential of blockchain technology, the level of adoption varies significantly. IBM mentions so called auto pioneers which represent roughly 15% of the industry (of which 80% are OEMs and 20% suppliers). These auto pioneers show outstanding readiness to implement a commercial blockchain solution, forecast larger business network sizes and also recognise the importance of industry consortia.
One of the well-established industry consortia in the automotive ecosystem is the Mobility Open Blockchain Initiative (MOBI). The non-profit consortium has been launched by IBM together with BMW, Bosch, Ford, General Motors, Renault and a few other companies. The collaboration is dedicated to improving safety, affordability and availability of mobility services through the use of blockchain. Car manufacturer Daimler has established its own cryptocurrency called MobiCoin to reward drivers for displaying environment-friendly driving behaviours.
Let us now dive into the discussion of governance architecture of a blockchain application in the automotive industry. Within the following governance discussion, each of the three governance layers will be discussed in detail. The case study is use case-agnostic and it is assumed that the idea has been successfully validated through a proof-of-concept supported by a respective minimum viable ecosystem. Minimum viable ecosystem is understood to be “the smallest configuration of elements that can be brought together and still create unique commercial value” (after Ron Adner in The Wide Lens). Only the involvement of a minimum viable ecosystem can generate insights, confirmations and mutual trust required for a production-grade deployment of commercial blockchain applications. Nevertheless, it is highly recommended to already start thinking about the governance aspects while assessing the commercial viability of such a business network.
1. Business network layer
As stated above, one of the key challenges of forming a blockchain consortia is balancing the interests of the initiators and the later-joiners. The initiators are particularly interested in their return on investment (RoI), a consideration which is also articulated in Deloitte’s survey as one of the biggest barriers to blockchain adoption (uncertain RoI). On the flip side, for the later-joiners particularly it is not attractive to join a business network whose interests are governed by a very small group of players. This becomes even more crucial if the initiators are industry leaders or key competitors. In such cases, the coopetition paradox urges the operators of the business network to open up towards competitors to materialise the strategic value of the network for all contributors.
Legal setup: A centralized legal entity governed by open governance principles is the preferred standard, particularly given the administration and compliance management considerations
Such context calls for the installation of a central legal entity for the business network, a so-called network operating company acting as a benevolent dictator. The network operating company would be in charge for the development (incl. community building), administration and commercialisation of the blockchain application. Any intellectual property accruing from the activities of the business networks would be assigned to the network operating company. However, the software package required to access the platform should be offered as a free, restrictive, open-source license to enable its adoption within the ecosystem.
This centralised approach enhances transparency within the business network and compliance with respective laws especially in the field anti-trust and data protection. In case there is no such central legal entity, there would likely be a general partnership or relevant contracts would have to be concluded. Overall, the central entity approach seems to outperform other alternatives in terms of administration and regulatory compliance, particularly when heading towards the production stage of the blockchain network. In our view, the operation of such a blockchain ecosystem / network via a partnership or a web of contracts would be inefficient and more cumbersome.
However, not every network member has similar interests, since some like to assume a more active role in the management and technical deployment of the network while others just simply want to use the blockchain application as a service through an API-access.
Co-initiators and later-joiners with a deeper interest in the platform should be allowed to have equity in the network operating company. A similar model is actually also pursued by Good Money, a Los Angeles-based digital banking platform, which grants equity to customers opening a bank account.
In this respect, it is recommended to cap the equity shareholding of the initiators at a certain level in order to attract new joiners in the ranks of the equity holders. Furthermore, equity holders must agree to and sign the respective shareholder agreement restricting the transferability of their equity interests and to avoid building of owner blocks.
Overall, it is implied that the network operating company is owned by a multitude of different automotive ecosystem members from the beginning to avoid the criticism laid on TradeLens. More explicitly, if the application is focused on the automotive supply chain, automakers, logistics companies, suppliers as well as OEMs should be on board from the very inception of such a network / application. This has been accomplished by MOBI at its current stage, as a non-profit consortium, which is primarily focused on establishing common standards.
Organisation: The organisational governance must account for the interests of both the equity holders and the community
The equity holders of the network operating company elect the members of the board of directors representing their respective interests. Then, the board itself appoints an executive management team in charge of the day-to-day operations of the business network and thereby the platform. This encompasses the development, community building, administration and marketing of the platform to the automotive ecosystem (see also the executive team of MOBI).
Since successful community building is instrumental, it is recommended to grant non-equity holding customers a voice by establishing a so-called community council. This body can be approached for consultation in case of key product development matters, changes to membership admission policies or protocol and data privacy related matters. The community council should be led by a chairperson who works closely with the board / executive team of the network operating company (likely also to be financed by this company). Care should be taken to make sure that this chairperson is independent and thereby not associated with any equity holder in the network operating company.
Commercial model: Reaching mass adoption through open-source business models
In order to ensure maximum reach and acceptance within the automotive ecosystem, it is recommended to open-source the platform to the community. This means that basic access to the platform is granted for free, provided that the node operation is handled by the respective member. Besides the free access to the software, it is expected that a subscription-based API-access model is offered, which is tailored to the needs of large enterprise customers as well as smaller network members.
In turn, the network operating company has a (recurring) revenue stream to cover its infrastructure as well as community building costs.
2. Protocol layer
The initial protocol layer is defined by the initiators of the business network during the assessment undertaken in the proof-of-concept. In general, the framework used should be based on an open-source standard such as Hyperledger Fabric, R3 Corda or Ethereum. This facilitates the integration into legacy systems for the users. Furthermore, the above-mentioned blockchain frameworks also enjoy prominent support by companies operating in the automotive ecosystem.
Moreover, in case changes to the protocol become necessary, the network operating company can consult the community council for consent prior to its implementation.
3. Data layer
Firstly, the blockchain application should be built upon the principle of privacy by design. Any data should only belong to its original owner and can only be transacted in agreement with the data owner. The network operating company is never expected to assume any data ownership other than its own.
Moreover, the network operating company should act as the data controller and data processor in line with the applicable data protection laws. Lastly, the data storage is ideally decentralised (e.g. point-to-point communication or IPFS), although the relevant solutions need to mature further.
Closing remarks
The coopetition paradox forces blockchain consortia to break up fierce competition between industry rivals in order to access the strategic value of such a business network.
Obviously, there is no one-size-fits-all solution to this topic, even though we have tried to come up with a holistic approach. However, we firmly believe that adhering to a multi-layered approach regarding blockchain consortia governance results in the establishment of mutual trust among the ecosystem members.
Although this article does not consider cryptoeconomics for enterprise blockchains (as called for example by Rory Houston of Skyynetwork) to resolve the governance misalignments, we fundamentally believe that cryptoeconomics will be a key building stone for delivering decentralised autonomous organisation, fully disintermediating ecosystems. But since there is still some way to go until mass adoption, we consider blockchain consortia as a fertile environment to deliver initial commercially viable solutions.
Thank you very much for your interest as you have just made it to the very end! We hope you have enjoyed reading this contribution. Should you have any feedback, please do not hesitate to comment or leave a message here: kevin@ksquared.ch
Resources
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Roland Berger, Focus: The blockchain bandwagon — Is it time for automotive companies to start investing seriously in blockchain?, 2018
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