Four Ways that Digital Infrastructures Boost Corporate Value
Do investments in programming interfaces and platforms pay off? A new study says ‘yes.’
With all the corporate investment in digital infrastructure, where’s the ROI? That’s what several MIT-affiliated researchers wanted to fdetermine.
“In the information age, the value of a firm rests fundamentally on how it stores, shares and processes information,” wrote Seth Benzell, Jonathan Hersh, and Marshall Van Alstyne in a recent paper, How APIs Create Growth by Inverting the Firm. “Digital infrastructure is therefore central to a firm’s success.”
But how do digital infrastructures increase a firm’s value? One method is to make more efficient use of internal capital by modularizing, reconfiguring, and reusing the firms IT resources. A second method, used in platform businesses, is to leverage external capital by giving access to the firm’s resources to third parties, and capturing a share of the resulting surplus. Both methods require the implementation of Application Programming Interfaces (APIs), whether only for internal use by the firm’s developers, or externally to the firm’s platform partners.
Both methods also feature a modular architecture of re-mixable resources. “Modularity combines the advantages of standardization typically associated with high volume processes together with the advantages of customization typically associated with bespoke processes.”
The Importance of APIs
An API is described as “a set of routines, protocols, and tools that standardizes building software applications compatible with an associated program or database. APIs fundamentally are code that control access to information. … They govern the type and format of calls or communications that any application can make of another associated program. The answering program is agnostic about the source of the call, yet can require access permission, and the calling program need not know anything about the internal workings of the answering program. … When designing an API, the architect decides how much of the computer system or data to expose to which users. Being accessible on the web, these API endpoints act as a constant conduit to business processes that the firm itself specifies.”
Four Methods of Valuation
The authors developed a novel method to quantify the changes in a firm’s valuation based on its adoption of APIs by analyzing four unique data sets. They then applied their methods to systematically evaluate several different hypotheses on the potential impact of APIs on firms. Let me summarize their evaluation of four of these hypotheses.
- Implementing APIs increases market value by increasing internal efficiency such as the ability to repurpose capital
The authors tested this hypothesis by analyzing data from 34 firms that deployed APIs but didn’t exposed them for external use, that is, the APIs were only used internally within the firm. If those APIs increased the internal efficiency of the firms, it should make the firm more productive, enabling it to repurpose its capital and thus boost its investments.
The analysis was inconclusive, as it failed to find any clear impact of internal API adoption on a firm’s market value.
2. Implementing APIs increases market value through external or third-party contributions to value
Alternatively, if APIs primarily boost a firm’s value by what the authors refer to as inverting the firm — that is, by leveraging external rather than internal investments — then the portion of the firm’s value not explained by its own capital stock is the result of external APIs boosting the firm’s profitability and market value by enabling third parties to complement its offerings. Moreover, the extent to which external APIs benefit a particular firm should be a function of that firm’s level of engagement with its third party ecosystem.
Overall, the analysis showed that firms that adopted externally facing APIs grew and additional 38% over 16 years compared to non-adopters — a growth of roughly 2% per year.
“Almost all specifications show the intensity of engagement to be significantly correlated with market value growth, over and above the extensive margin of API adoption.” The growth increased with the length of time since API adoption, consistent with APIs growing in utility over time, and also consistent with a first-mover advantage in establishing a platform’s network.
“Together, these facts lead us to conclude that APIs, as the foundation of digital ecosystems, have a large and positive impact on economic growth and do so primarily by enabling external complementors rather than boosting internal productivity.”
3. Implementing consumer facing (B2C) APIs increases market value more than implementing business facing (B2B) APIs
Given the much larger number of consumers relative to producers we would expect the API impact to be greater for B2C than for B2B. In addition, B2C APIs — and B2C platforms in general — are better at driving network effects than B2B ones because it’s more immediately clear to third parties how to offer their products and services to consumers than to other firms. “B2B use cases focus on higher value opportunities with a smaller number of partners whereas B2C use cases focus on lower value opportunities with a higher number of partners.”
The analysis does indeed show that the most important and central APIs tend to come from B2C oriented firms.
4. Implementing APIs can create security holes. A firm’s adoption of externally facing APIs is associated with an increased risk of data breach.
While APIs provide important benefits, there’s as a potential important downside to their adoption: the increase risk of data breaches. “If APIs increased the risk of major loss or liability, their use would pose an important downside risk. There is a trade-off between an interest in enabling third party innovations and an interest in thwarting third party damage or ransom. Opening APIs can have both effects.”
An analysis of data from 78 firms showed that there was an increased risk of data breach in the two years following API adoption that can be connected to poorly secured APIs. Those firms that reported data breaches saw a decrease in API flows in the short run, but the flows rebounded over time. At the same time, the firms that reported data breaches significantly increased the testing of their APIs in the months after the data breach was reported.
“Together, these results show, quantitatively, that APIs are a critical aspect of the economy’s growing digital ecosystem,” the authors conclude. “Firms that use APIs to place themselves at the center of this ecosystem can expect large returns.”