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Strategy and the Internet Strategy and the Internet Document Transcript

  • Strategy and the Internet by Michael E. Porter Reprint r0103d
  • March 2001 HBR Case Study r0103a Mommy-Track Backlash Alden M. Hayashi First Person r0103b The Job No CEO Should Delegate Larry Bossidy HBR at Large r0103c The Nut Island Effect: When Good Teams Go Wrong Paul F Levy . Strategy and the Internet r0103d Michael E. Porter Building the Emotional Intelligence r0103e of Groups Vanessa Urch Druskat and Steven B. Wolff Not All M&As Are Alike – and That Matters r0103f Joseph L. Bower Introducing T-Shaped Managers: r0103g Knowledge Management’s Next Generation Morten T. Hansen and Bolko von Oetinger HBR Interview r0103h Tom Siebel of Siebel Systems: High Tech the Old-Fashioned Way Bronwyn Fryer Best Practice r0103j Unleash Innovation in Foreign Subsidiaries Julian Birkinshaw and Neil Hood Tool Kit r0103k Making the Most of On-Line Recruiting Peter Cappelli Books in Review r0103l Playing Around with Brainstorming Michael Schrage
  • 62 Copyright © 2001 by Harvard Business School Publishing Corporation. All rights reserved.
  • Many have argued that the Internet renders strategy obsolete. In reality, the opposite is true. Because the Internet tends to weaken industry profitability without providing proprietary operational advantages, it is more important than ever for companies to distinguish themselves through strategy. The winners will be those that view the Internet as a complement to, not a cannibal of, traditional ways of competing. Strategy and the Internet by Michael E. Porter T he Internet is an extremely important new technology, and it is no surprise that it has received so much attention from entrepreneurs, executives, investors, and business observers. Caught up in the general fervor, many have as- sumed that the Internet changes everything, ren- dering all the old rules about companies and com- petition obsolete. That may be a natural reaction, but it is a dangerous one. It has led many compa- nies, dot-coms and incumbents alike, to make bad decisions – decisions that have eroded the attrac- tiveness of their industries and undermined their own competitive advantages. Some companies, for ILLUSTRATION BY MICHAEL GIBBS example, have used Internet technology to shift the basis of competition away from quality, fea- tures, and service and toward price, making it harder for anyone in their industries to turn a profit. Others have forfeited important proprietary advantages by rushing into misguided partnerships march 2001 63
  • S t rat e g y a n d t h e I n t e r n e t and outsourcing relationships. Until recently, the negative tional approaches in ways that buttress existing advan- effects of these actions have been obscured by distorted tages. But dot-coms can also be winners – if they under- signals from the marketplace. Now, however, the conse- stand the trade-offs between Internet and traditional quences are becoming evident. approaches and can fashion truly distinctive strategies. The time has come to take a clearer view of the Inter- Far from making strategy less important, as some have net. We need to move away from the rhetoric about argued, the Internet actually makes strategy more essen- “Internet industries,” “e-business strategies,” and a “new tial than ever. economy” and see the Internet for what it is: an enabling technology – a powerful set of tools that can be used, wisely or unwisely, in almost any industry and as part of Distorted Market Signals almost any strategy. We need to ask fundamental ques- Companies that have deployed Internet technology have tions: Who will capture the economic benefits that the been confused by distorted market signals, often of their Internet creates? Will all the value end up going to cus- own creation. It is understandable, when confronted with tomers, or will companies be able to reap a share of it? a new business phenomenon, to look to marketplace out- What will be the Internet’s impact on industry structure? comes for guidance. But in the early stages of the rollout Will it expand or shrink the pool of profits? And what will of any important new technology, market signals can be be its impact on strategy? Will the Internet bolster or unreliable. New technologies trigger rampant experi- erode the ability of companies to gain sustainable advan- mentation, by both companies and customers, and the tages over their competitors? experimentation is often economically unsustainable. As In addressing these questions, much of what we find is a result, market behavior is distorted and must be inter- unsettling. I believe that the experiences companies have preted with caution. had with the Internet thus far must be largely discounted That is certainly the case with the Internet. Consider and that many of the lessons learned must be forgotten. the revenue side of the profit equation in industries in When seen with fresh eyes, it becomes clear that the In- which Internet technology is widely used. Sales figures ternet is not necessarily a blessing. It tends to alter indus- have been unreliable for three reasons. First, many com- try structures in ways that dampen overall profitability, panies have subsidized the purchase of their products and and it has a leveling effect on business practices, reducing services in hopes of staking out a position on the Internet the ability of any company to establish an operational and attracting a base of customers. (Governments have advantage that can be sustained. also subsidized on-line shopping by exempting it from The key question is not whether to deploy Internet sales taxes.) Buyers have been able to purchase goods at technology – companies have no choice if they want to heavy discounts, or even obtain them for free, rather than stay competitive – but how to deploy it. Here, there is rea- pay prices that reflect true costs. When prices are artifi- son for optimism. Internet technology provides better op- cially low, unit demand becomes artificially high. Second, portunities for companies to establish distinctive strategic many buyers have been drawn to the Internet out of positionings than did previous generations of informa- curiosity; they have been willing to conduct transactions tion technology. Gaining such a competitive advantage on-line even when the benefits have been uncertain or does not require a radically new approach to business. It limited. If Amazon.com offers an equal or lower price requires building on the proven principles of effective than a conventional bookstore and free or subsidized strategy. The Internet per se will rarely be a competitive shipping, why not try it as an experiment? Sooner or later, advantage. Many of the companies that succeed will be though, some customers can be expected to return to ones that use the Internet as a complement to traditional more traditional modes of commerce, especially if sub- ways of competing, not those that set their Internet ini- sidies end, making any assessment of customer loyalty tiatives apart from their established operations. That is based on conditions so far suspect. Finally, some “rev- particularly good news for established companies, which enues” from on-line commerce have been received in the are often in the best position to meld Internet and tradi- form of stock rather than cash. Much of the estimated $450 million in revenues that Amazon has recognized Michael E. Porter is the Bishop William Lawrence Univer- from its corporate partners, for example, has come as sity Professor at Harvard University; he is based at Har- stock. The sustainability of such revenue is questionable, vard Business School in Boston. He has written many arti- and its true value hinges on fluctuations in stock prices. cles for HBR; the most recent,“Philanthropy’s New Agenda: If revenue is an elusive concept on the Internet, cost is Creating Value,” coauthored by Mark R. Kramer, appeared equally fuzzy. Many companies doing business on-line in the November–December 1999 issue. His book Can Japan have enjoyed subsidized inputs. Their suppliers, eager to Compete?, coauthored by Hirotaka Takeuchi and Mariko affiliate themselves with and learn from dot-com leaders, Sakakibara, was recently published in the United States by have provided products, services, and content at heavily Perseus/Basic Books. discounted prices. Many content providers, for example, 64 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t rushed to provide their information to Yahoo! for next to so rapidly for one major reason: they were able to raise nothing in hopes of establishing a beachhead on one of capital without having to demonstrate viability. Rather the Internet’s most visited sites. Some providers have even than signaling a healthy business environment, the sheer paid popular portals to distribute their content. Further number of dot-coms in many industries often revealed masking true costs, many suppliers – not to mention em- nothing more than the existence of low barriers to entry, ployees – have agreed to accept equity, warrants, or stock always a danger sign. options from Internet-related companies and ventures in payment for their services or products. Payment in equity does not appear on the income statement, but it is a real A Return to Fundamentals cost to shareholders. Such supplier practices have artifi- It is hard to come to any firm understanding of the impact cially depressed the costs of doing business on the Inter- of the Internet on business by looking at the results to net, making it appear more attractive than it really is. date. But two broad conclusions can be drawn. First, many Finally, costs have been distorted by the systematic un- businesses active on the Internet are artificial businesses derstatement of the need for capital. Company after com- competing by artificial means and propped up by capital pany touted the low asset intensity of doing business on- that until recently had been readily available. Second, in line, only to find that inventory, warehouses, and other periods of transition such as the one we have been going investments were necessary to provide value to customers. through, it often appears as if there are new rules of com- Signals from the stock market have been even more petition. But as market forces play out, as they are now, unreliable. Responding to investor enthusiasm over the the old rules regain their currency. The creation of true Internet’s explosive growth, stock valuations became economic value once again becomes the final arbiter of decoupled from business fundamentals. They no longer business success. provided an accurate guide as to whether real economic Economic value for a company is nothing more than value was being created. Any company that has made the gap between price and cost, and it is reliably mea- competitive decisions based on influencing near-term sured only by sustained profitability. To generate rev- share price or responding to investor sentiments has put enues, reduce expenses, or simply do something useful by itself at risk. deploying Internet technology is not sufficient evidence Distorted revenues, costs, and share prices have been that value has been created. Nor is a company’s current matched by the unreliability of the financial metrics that stock price necessarily an indicator of economic value. companies have adopted. The executives of companies Shareholder value is a reliable measure of economic conducting business over the Internet have, conveniently, value only over the long run. downplayed traditional measures of profitability and eco- In thinking about economic value, it is useful to draw nomic value. Instead, they have emphasized expansive a distinction between the uses of the Internet (such as definitions of revenue, numbers of customers, or, even more suspect, measures that might Internet technology provides better opportunities for someday correlate with reve- nue, such as numbers of unique companies to establish distinctive strategic positionings users (“reach”), numbers of site than did previous generations of information technology. visitors, or click-through rates. Creative accounting approaches have also multiplied. Indeed, the Internet has given rise to operating digital marketplaces, selling toys, or trading an array of new performance metrics that have only a securities) and Internet technologies (such as site-cus- loose relationship to economic value, such as pro forma tomization tools or real-time communications services), measures of income that remove “nonrecurring”costs like which can be deployed across many uses. Many have acquisitions. The dubious connection between reported pointed to the success of technology providers as evi- metrics and actual profitability has served only to amplify dence of the Internet’s economic value. But this thinking the confusing signals about what has been working in the is faulty. It is the uses of the Internet that ultimately marketplace. The fact that those metrics have been taken create economic value. Technology providers can prosper seriously by the stock market has muddied the waters for a time irrespective of whether the uses of the Internet even further. For all these reasons, the true financial per- are profitable. In periods of heavy experimentation, even formance of many Internet-related businesses is even sellers of flawed technologies can thrive. But unless the worse than has been stated. uses generate sustainable revenues or savings in excess of One might argue that the simple proliferation of dot- their cost of deployment, the opportunity for technology coms is a sign of the economic value of the Internet. Such providers will shrivel as companies realize that further a conclusion is premature at best. Dot-coms multiplied investment is economically unsound. march 2001 65
  • S t rat e g y a n d t h e I n t e r n e t So how can the Internet be used to create economic mistake to draw general conclusions about the impact value? To find the answer, we need to look beyond the im- of the Internet on long-term industry profitability; each mediate market signals to the two fundamental factors industry is affected in different ways. Nevertheless, an that determine profitability: examination of a wide range of industries in which the • industry structure, which determines the profitability of Internet is playing a role reveals some clear trends, as the average competitor; and summarized in the exhibit “How the Internet Influences • sustainable competitive advantage, which allows a com- Industry Structure.” Some of the trends are positive. For pany to outperform the average competitor. example, the Internet tends to dampen the bargaining These two underlying drivers of profitability are uni- power of channels by providing companies with new, versal; they transcend any technology or type of business. more direct avenues to customers. The Internet can also At the same time, they vary widely by industry and com- boost an industry’s efficiency in various ways, expanding pany. The broad, supra-industry classifications so common the overall size of the market by improving its position in Internet parlance, such as business-to-consumer (or relative to traditional substitutes. “B2C”) and business-to-business (or “B2B”) prove mean- But most of the trends are negative. Internet technol- ingless with respect to profitability. Potential profitability ogy provides buyers with easier access to information can be understood only by looking at individual indus- about products and suppliers, thus bolstering buyer bar- tries and individual companies. gaining power. The Internet mitigates the need for such things as an established sales force or access to existing channels, reducing barriers to entry. By enabling new The Internet and Industry Structure approaches to meeting needs and performing functions, The Internet has created some new industries, such as it creates new substitutes. Because it is an open system, on-line auctions and digital marketplaces. However, its companies have more difficulty maintaining proprietary greatest impact has been to enable the reconfiguration offerings, thus intensifying the rivalry among competi- of existing industries that had been constrained by high tors. The use of the Internet also tends to expand the costs for communicating, gathering information, or ac- geographic market, bringing many more companies into complishing transactions. Distance learning, for example, competition with one another. And Internet technologies has existed for decades, with about one million students tend to reduce variable costs and tilt cost structures to- enrolling in correspondence courses every year. The In- ward fixed cost, creating significantly greater pressure for ternet has the potential to greatly expand distance learn- companies to engage in destructive price competition. ing, but it did not create the industry. Similarly, the Inter- While deploying the Internet can expand the market, net provides an efficient means to order products, but then, doing so often comes at the expense of average prof- catalog retailers with toll-free numbers and automated itability. The great paradox of the Internet is that its very fulfillment centers have been around for decades. The In- benefits – making information widely available; reducing ternet only changes the front end of the process. the difficulty of purchasing, marketing, and distribution; Whether an industry is new or old, its structural attrac- allowing buyers and sellers to find and transact business tiveness is determined by five underlying forces of com- with one another more easily–also make it more difficult petition: the intensity of rivalry among existing competi- for companies to capture those benefits as profits. tors, the barriers to entry for new competitors, the threat We can see this dynamic at work in automobile retail- of substitute products or services, the bargaining power of ing. The Internet allows customers to gather extensive suppliers, and the bargaining power of buyers. In combi- information about products easily, from detailed speci- nation, these forces determine how the economic value fications and repair records to wholesale prices for new created by any product, service, technology, or way of cars and average values for used cars. Customers can also competing is divided between, on the one hand, compa- choose among many more options from which to buy, not nies in an industry and, on the other, customers, suppliers, just local dealers but also various types of Internet refer- distributors, substitutes, and potential new entrants. Al- ral networks (such as Autoweb and AutoVantage) and on- though some have argued that today’s rapid pace of tech- line direct dealers (such as Autobytel.com, AutoNation, nological change makes industry analysis less valuable, and CarsDirect.com). Because the Internet reduces the the opposite is true. Analyzing the forces illuminates an importance of location, at least for the initial sale, it industry’s fundamental attractiveness, exposes the under- widens the geographic market from local to regional or lying drivers of average industry profitability, and provides national. Virtually every dealer or dealer group becomes insight into how profitability will evolve in the future. The a potential competitor in the market. It is more difficult, five competitive forces still determine profitability even if moreover, for on-line dealers to differentiate themselves, suppliers, channels, substitutes, or competitors change. as they lack potential points of distinction such as show- Because the strength of each of the five forces varies rooms, personal selling, and service departments. With considerably from industry to industry, it would be a more competitors selling largely undifferentiated prod- 66 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t ucts, the basis for competition shifts ever more toward industry has been defined, largely by eBay, the dominant price. Clearly, the net effect on the industry’s structure is competitor, in terms of providing an easy-to-use market- negative. place in which revenue comes from listing and sales fees, That does not mean that every industry in which while customers pay the cost of shipping. When Amazon Internet technology is being applied will be unattractive. and other rivals entered the business, offering free auc- For a contrasting example, look at Internet auctions. tions, eBay maintained its prices and pursued other ways Here, customers and suppliers are fragmented and thus to attract and retain customers. As a result, the destructive have little power. Substitutes, such as classified ads and price competition characteristic of other on-line busi- flea markets, have less reach and are less convenient to nesses has been avoided. use. And though the barriers to entry are relatively mod- EBay’s role in the auction business provides an impor- est, companies can build economies of scale, both in infra- tant lesson: industry structure is not fixed but rather is structure and, even more important, in the aggregation shaped to a considerable degree by the choices made by of many buyers and sellers, that deter new competitors competitors. EBay has acted in ways that strengthen the or place them at a disadvantage. Finally, rivalry in this profitability of its industry. In stark contrast, Buy.com, How the Internet Influences Industry Structure (+) By making the overall industry Threat of substitute more efficient, the Internet can products or services expand the size of the market (-) The proliferation of Internet approaches creates new substitution threats Buyers Bargaining power Bargaining power Rivalry among Bargaining Bargaining of suppliers of suppliers existing competitors power of power of channels end users (+/-) Procurement using the Internet (-) Reduces differences among (+) Eliminates (-) Shifts tends to raise bargaining power competitors as offerings are powerful bargaining over suppliers, though it can also difficult to keep proprietary channels or power to end give suppliers access to more improves consumers (-) Migrates competition to price customers bargaining (-) Reduces (-) Widens the geographic market, power over (-) The Internet provides a channel switching increasing the number of traditional for suppliers to reach end users, costs competitors channels reducing the leverage of intervening companies (-) Lowers variable cost relative to fixed cost, increasing pressures (-) Internet procurement and digital for price discounting markets tend to give all companies equal access to suppliers, and gravitate procurement to standardized products that reduce differentiation (-) Reduced barriers to entry and (-) Reduces barriers to entry such as the the proliferation of competitors need for a sales force, access to channels, downstream shifts power to and physical assets – anything that suppliers Barriers to entry Internet technology eliminates or makes easier to do reduces barriers to entry (-) Internet applications are difficult to keep proprietary from new entrants (-) A flood of new entrants has come into many industries This discussion is drawn from the author’s research with David Sutton. For a fuller discussion, see M.E. Porter, Competitive Strategy, Free Press, 1980. march 2001 67
  • S t rat e g y a n d t h e I n t e r n e t a prominent Internet retailer, acted in ways that under- company’s user interface and would not want to bear the mined its industry, not to mention its own potential for cost of finding, registering with, and learning to use a competitive advantage. Buy.com achieved $100 million in competitor’s site, or, in the case of industrial customers, sales faster than any company in history, but it did so by integrating a competitor’s systems with its own. More- defining competition solely on price. It sold products not over, since Internet commerce allows a company to accu- only below full cost but at or below cost of goods sold, mulate knowledge of customers’ buying behavior, the with the vain hope that it would make money in other company would be able to provide more tailored offer- ways. The company had no plan for being the low-cost ings, better service, and greater purchasing conve- provider; instead, it invested heavily in brand advertising nience – all of which buyers would be loath to forfeit. and eschewed potential sources of differentiation by out- When people talk about the “stickiness” of Web sites, sourcing all fulfillment and offering the bare minimum what they are often talking about is high switching costs. of customer service. It also gave up the opportunity to In reality, though, switching costs are likely to be lower, set itself apart from competitors by choosing not to focus not higher, on the Internet than they are for traditional on selling particular goods; it moved quickly beyond ways of doing business, including approaches using electronics, its initial category, into numerous other earlier generations of information systems such as EDI. product categories in which it had no unique offering. On the Internet, buyers can often switch suppliers with Although the company has been trying desperately to just a few mouse clicks, and new Web technologies are reposition itself, its early moves have proven extremely systematically reducing switching costs even further. For difficult to reverse. example, companies like PayPal provide settlement services or Internet currency – so-called e-wallets – that enable customers to shop at different sites without having The Myth of the First Mover to enter personal information and credit card numbers. Given the negative implications of the Internet for prof- Content-consolidation tools such as OnePage allow users itability, why was there such optimism, even euphoria, to avoid having to go back to sites over and over to re- surrounding its adoption? One reason is that everyone trieve information by enabling them to build customized tended to focus on what the Internet could do and how Web pages that draw needed information dynamically quickly its use was expanding rather than on how it was from many sites. And the widespread adoption of XML affecting industry structure. But the optimism can also be standards will free companies from the need to reconfigure traced to a widespread belief that the Internet would proprietary ordering systems and to create new procure- unleash forces that would enhance industry profitability. ment and logistical protocols when changing suppliers. Most notable was the general assumption that the de- What about network effects, through which products ployment of the Internet would increase switching costs or services become more valuable as more customers and create strong network effects, which would provide use them? A number of important Internet applications first movers with competitive advantages and robust prof- display network effects, including e-mail, instant mes- itability. First movers would reinforce these advantages saging, auctions, and on-line message boards or chat by quickly establishing strong new-economy brands. The rooms. Where such effects are significant, they can create demand-side economies of scale and raise barriers to entry. This, it has Another myth that has generated unfounded been widely argued, sets off a winner- take-all competition, leading to the enthusiasm for the Internet is that partnering is eventual dominance of one or two a win-win means to improve industry economics. companies. But it is not enough for network effects to be present; to provide bar- result would be an attractive industry for the victors. This riers to entry they also have to be proprietary to one com- thinking does not, however, hold up to close examination. pany. The openness of the Internet, with its common stan- Consider switching costs. Switching costs encompass dards and protocols and its ease of navigation, makes it all the costs incurred by a customer in changing to a new difficult for a single company to capture the benefits of supplier – everything from hashing out a new contract a network effect. (America Online, which has managed to reentering data to learning how to use a different to maintain borders around its on-line community, is an product or service. As switching costs go up, customers’ exception, not the rule.) And even if a company is lucky bargaining power falls and the barriers to entry into an in- enough to control a network effect, the effect often dustry rise. While switching costs are nothing new, some reaches a point of diminishing returns once there is a observers argued that the Internet would raise them critical mass of customers. Moreover, network effects are substantially. A buyer would grow familiar with one subject to a self-limiting mechanism. A particular product 68 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t or service first attracts the customers whose needs it best alike, which heats up rivalry. Instead of focusing on their meets. As penetration grows, however, it will tend to be- own strategic goals, moreover, companies are forced to come less effective in meeting the needs of the remaining balance the many potentially conflicting objectives of customers in the market, providing an opening for com- their partners while also educating them about the busi- petitors with different offerings. Finally, creating a net- ness. Rivalry often becomes more unstable, and since pro- work effect requires a large investment that may offset ducers of complements can be potential competitors, the future benefits. The network effect is, in many respects, threat of entry increases. akin to the experience curve, which was also supposed to Another common form of partnering is outsourcing. lead to market-share dominance – through cost advan- Internet technologies have made it easier for companies tages, in that case. The experience curve was an oversim- to coordinate with their suppliers, giving widespread cur- plification, and the single-minded pursuit of experience rency to the notion of the “virtual enterprise”– a business curve advantages proved disastrous in many industries. created largely out of purchased products, components, Internet brands have also proven difficult to build, and services. While extensive outsourcing can reduce perhaps because the lack of physical presence and direct near-term costs and improve flexibility, it has a dark side human contact makes virtual businesses less tangible to when it comes to industry structure. As competitors turn customers than traditional businesses. Despite huge out- to the same vendors, purchased inputs become more lays on advertising, product discounts, and purchasing homogeneous, eroding company distinctiveness and incentives, most dot-com brands have not approached the increasing price competition. Outsourcing also usually power of established brands, achieving only a modest lowers barriers to entry because a new entrant need only impact on loyalty and barriers to entry. assemble purchased inputs rather than build its own Another myth that has generated unfounded enthusi- capabilities. In addition, companies lose control over im- asm for the Internet is that partnering is a win-win means portant elements of their business, and crucial experience to improve industry economics. While partnering is a in components, assembly, or services shifts to suppliers, well-established strategy, the use of Internet technology enhancing their power in the long run. has made it much more widespread. Partnering takes two forms. The first involves complements: products that are used in tandem with another industry’s product. Com- The Future of Internet Competition puter software, for example, is a complement to computer While each industry will evolve in unique ways, an exam- hardware. In Internet commerce, complements have pro- ination of the forces influencing industry structure indi- liferated as companies have sought to offer broader arrays cates that the deployment of Internet technology will of products, services, and information. Partnering to as- likely continue to put pressure on the profitability of semble complements, often with companies who are also many industries. Consider the intensity of competition, competitors, has been seen as a way to speed industry for example. Many dot-coms are going out of business, growth and move away from narrow-minded, destructive which would seem to indicate that consolidation will take competition. place and rivalry will be reduced. But while some consol- But this approach reveals an incomplete understanding idation among new players is inevitable, many established of the role of complements in competition. Complements companies are now more familiar with Internet technol- are frequently important to an industry’s growth–spread- ogy and are rapidly deploying on-line applications. With sheet applications, for example, accelerated the expansion a combination of new and old companies and generally of the personal computer industry – but they have no lower entry barriers, most industries will likely end up direct relationship to industry profitability. While a close with a net increase in the number of competitors and substitute reduces potential profitability, for example, a fiercer rivalry than before the advent of the Internet. close complement can exert either a positive or a negative The power of customers will also tend to rise. As buy- influence. Complements affect industry profitability ers’ initial curiosity with the Web wanes and subsidies indirectly through their influence on the five competitive end, companies offering products or services on-line will forces. If a complement raises switching costs for the com- be forced to demonstrate that they provide real benefits. bined product offering, it can raise profitability. But if Already, customers appear to be losing interest in services a complement works to standardize the industry’s prod- like Priceline.com’s reverse auctions because the savings uct offering, as Microsoft’s operating system has done in they provide are often outweighed by the hassles in- personal computers, it will increase rivalry and depress volved. As customers become more familiar with the tech- profitability. nology, their loyalty to their initial suppliers will also de- With the Internet, widespread partnering with pro- cline; they will realize that the cost of switching is low. ducers of complements is just as likely to exacerbate an A similar shift will affect advertising-based strategies. industry’s structural problems as mitigate them. As part- Even now, advertisers are becoming more discriminat- nerships proliferate, companies tend to become more ing, and the rate of growth of Web advertising is slowing. march 2001 69
  • S t rat e g y a n d t h e I n t e r n e t Advertisers can be expected to continue to exercise their ited. Anything buyers or suppliers provide to a market- bargaining power to push down rates significantly, aided place, such as information on order specifications or in- and abetted by new brokers of Internet advertising. ventory availability, can be readily provided on their own Not all the news is bad. Some technological advances proprietary sites. Suppliers and customers can begin to will provide opportunities to enhance profitability. Im- deal directly on-line without the need for an intermedi- provements in streaming video and greater availability ary. And new technologies will undoubtedly make it eas- of low-cost bandwidth, for example, will make it easier ier for parties to search for and exchange goods and for customer service representatives, or other company information with one another. personnel, to speak directly to customers through their In some product areas, marketplaces should enjoy computers. Internet sellers will be able to better differen- ongoing advantages and attractive profitability. In frag- tiate themselves and shift buyers’ focus away from price. mented industries such as real estate and furniture, for And services such as automatic bill paying by banks may example, they could prosper. And new kinds of value- modestly boost switching costs. In general, however, new added services may arise that only an independent mar- Internet technologies will continue to erode profitability ketplace could provide. But in many product areas, by shifting power to customers. marketplaces may be superceded by direct dealing or by To understand the importance of thinking through the the unbundling of purchasing, information, financing, longer-term structural consequences of the Internet, con- and logistical services; in other areas, they may be taken sider the business of digital marketplaces. Such market- over by participants or industry associations as cost cen- places automate corporate procurement by linking many ters. In such cases, marketplaces will provide a valuable buyers and suppliers electronically. The benefits to buyers “public good” to participants but will not themselves be include low transaction costs, easier access to price and likely to reap any enduring benefits. Over the long haul, product information, convenient purchase of associated moreover, we may well see many buyers back away from services, and, sometimes, the ability to pool volume. The open marketplaces. They may once again focus on build- benefits to suppliers include lower selling costs, lower ing close, proprietary relationships with fewer suppliers, transaction costs, access to wider markets, and the avoid- using Internet technologies to gain efficiency improve- ance of powerful channels. ments in various aspects of those relationships. From an industry structure standpoint, the attractive- ness of digital marketplaces varies depending on the prod- The Internet and ucts involved. The most important determinant of a mar- ketplace’s profit potential is the intrinsic power of the Competitive Advantage buyers and sellers in the particular product area. If either If average profitability is under pressure in many indus- side is concentrated or possesses differentiated products, tries influenced by the Internet, it becomes all the more it will gain bargaining power over the marketplace and important for individual companies to set themselves capture most of the value generated. If buyers and sellers apart from the pack – to be more profitable than the av- are fragmented, however, their bargaining power will be erage performer. The only way to do so is by achieving weak, and the marketplace will have a much better chance a sustainable competitive advantage – by operating at a of being profitable. Another important determinant of lower cost, by commanding a premium price, or by doing industry structure is the threat of substitution. If it is both. Cost and price advantages can be achieved in two relatively easy for buyers and sellers to transact business ways. One is operational effectiveness – doing the same directly with one another, or to set up their own dedicated things your competitors do but doing them better. Oper- markets, independent marketplaces will be unlikely to ational effectiveness advantages can take myriad forms, sustain high levels of profit. Finally, the ability to create including better technologies, superior inputs, better- barriers to entry is critical. Today, with dozens of market- trained people, or a more effective management struc- places competing in some industries and with buyers and ture. The other way to achieve advantage is strategic sellers dividing their purchases or operating their own positioning – doing things differently from competitors, markets to prevent any one marketplace from gaining in a way that delivers a unique type of value to customers. power, it is clear that modest entry barriers are a real This can mean offering a different set of features, a dif- challenge to profitability. ferent array of services, or different logistical arrange- Competition among digital marketplaces is in transi- ments. The Internet affects operational effectiveness and tion, and industry structure is evolving. Much of the eco- strategic positioning in very different ways. It makes it nomic value created by marketplaces derives from the harder for companies to sustain operational advantages, standards they establish, both in the underlying technol- but it opens new opportunities for achieving or strength- ogy platform and in the protocols for connecting and ening a distinctive strategic positioning. exchanging information. But once these standards are put Operational Effectiveness. The Internet is arguably in place, the added value of the marketplace may be lim- the most powerful tool available today for enhancing 70 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t operational effectiveness. By easing and speed- ing the exchange of real-time information, it The Six Principles enables improvements throughout the entire value chain, across almost every company and of Strategic Positioning industry. And because it is an open platform with common standards, companies can often To establish and maintain a distinctive strategic positioning, a company tap into its benefits with much less investment needs to follow six fundamental principles. than was required to capitalize on past genera- First, it must start with the right goal: superior long-term return on tions of information technology. investment. Only by grounding strategy in sustained profitability will real But simply improving operational effective- economic value be generated. Economic value is created when customers ness does not provide a competitive advantage. are willing to pay a price for a product or service that exceeds the cost of Companies only gain advantages if they are producing it. When goals are defined in terms of volume or market share able to achieve and sustain higher levels of op- leadership, with profits assumed to follow, poor strategies often result. The erational effectiveness than competitors. That is same is true when strategies are set to respond to the perceived desires an exceedingly difficult proposition even in the of investors. best of circumstances. Once a company estab- Second, a company’s strategy must enable it to deliver a value proposi- lishes a new best practice, its rivals tend to copy tion, or set of benefits, different from those that competitors offer. Strategy, it quickly. Best practice competition eventually then, is neither a quest for the universally best way of competing nor an leads to competitive convergence, with many effort to be all things to every customer. It defines a way of competing that companies doing the same things in the same delivers unique value in a particular set of uses or for a particular set of ways. Customers end up making decisions based customers. on price, undermining industry profitability. Third, strategy needs to be reflected in a distinctive value chain. To estab- The nature of Internet applications makes it lish a sustainable competitive advantage, a company must perform differ- more difficult to sustain operational advantages ent activities than rivals or perform similar activities in different ways. than ever. In previous generations of informa- A company must configure the way it conducts manufacturing, logistics, tion technology, application development was service delivery, marketing, human resource management, and so on dif- often complex, arduous, time consuming, and ferently from rivals and tailored to its unique value proposition. If a com- hugely expensive. These traits made it harder pany focuses on adopting best practices, it will end up performing most to gain an IT advantage, but they also made it activities similarly to competitors, making it hard to gain an advantage. Fourth, robust strategies involve trade-offs. A company must abandon difficult for competitors to imitate informa- or forgo some product features, services, or activities in order to be unique tion systems. The openness of the Internet, at others. Such trade-offs, in the product and in the value chain, are what combined with advances in software architec- make a company truly distinctive. When improvements in the product or ture, development tools, and modularity, makes in the value chain do not require trade-offs, they often become new best it much easier for companies to design and practices that are imitated because competitors can do so with no sacrifice implement applications. The drugstore chain to their existing ways of competing. Trying to be all things to all customers CVS, for example, was able to roll out a complex almost guarantees that a company will lack any advantage. Internet-based procurement application in just Fifth, strategy defines how all the elements of what a company does fit 60 days. As the fixed costs of developing systems together. A strategy involves making choices throughout the value chain decline, the barriers to imitation fall as well. that are interdependent; all a company’s activities must be mutually rein- Today, nearly every company is developing forcing. A company’s product design, for example, should reinforce its ap- similar types of Internet applications, often proach to the manufacturing process, and both should leverage the way it drawing on generic packages offered by third- conducts after-sales service. Fit not only increases competitive advantage party developers. The resulting improvements but also makes a strategy harder to imitate. Rivals can copy one activity or in operational effectiveness will be broadly product feature fairly easily, but will have much more difficulty duplicating shared, as companies converge on the same a whole system of competing. Without fit, discrete improvements in applications with the same benefits. Very rarely manufacturing, marketing, or distribution are quickly matched. will individual companies be able to gain dura- Finally, strategy involves continuity of direction. A company must define ble advantages from the deployment of “best- a distinctive value proposition that it will stand for, even if that means forgo- of-breed” applications. ing certain opportunities. Without continuity of direction, it is difficult for Strategic Positioning. As it becomes harder companies to develop unique skills and assets or build strong reputations to sustain operational advantages, strategic with customers. Frequent corporate “reinvention,” then, is usually a sign positioning becomes all the more important. If of poor strategic thinking and a route to mediocrity. Continuous improve- ment is a necessity, but it must always be guided by a strategic direction. a company cannot be more operationally effec- tive than its rivals, the only way to generate For a fuller description, see M.E. Porter, “What Is Strategy?” higher levels of economic value is to gain a cost (HBR November–December 1996). march 2001 71
  • S t rat e g y a n d t h e I n t e r n e t advantage or price premium by competing in a distinctive or anyone else will gain a competitive advantage. A de- way. Ironically, companies today define competition structive, zero-sum form of competition has been set in involving the Internet almost entirely in terms of opera- motion that confuses the acquisition of customers with tional effectiveness. Believing that no sustainable advan- the building of profitability. Worse yet, price has been de- tages exist, they seek speed and agility, hoping to stay one fined as the primary if not the sole competitive variable. step ahead of the competition. Of course, such an ap- Instead of emphasizing the Internet’s ability to support proach to competition becomes a self-fulfilling prophecy. convenience, service, specialization, customization, and Without a distinctive strategic direction, speed and flexi- other forms of value that justify attractive prices, compa- bility lead nowhere. Either no unique competitive advan- nies have turned competition into a race to the bottom. tages are created, or improvements are generic and can- Once competition is defined this way, it is very difficult not be sustained. to turn back. (See the sidebar “Words for the Unwise: The Having a strategy is a matter of discipline. It requires Internet’s Destructive Lexicon.”) a strong focus on profitability rather than just growth, Even well-established, well-run companies have been an ability to define a unique value proposition, and a will- thrown off track by the Internet. Forgetting what they ingness to make tough trade-offs in choosing what not to stand for or what makes them unique, they have rushed do. A company must stay the course, even during times to implement hot Internet applications and copy the of upheaval, while constantly improving and extending offerings of dot-coms. Industry leaders have compromised its distinctive positioning. Strategy goes far beyond the their existing competitive advantages by entering market pursuit of best practices. It involves the configuration of segments to which they bring little that is distinctive. a tailored value chain – the series of activities required Merrill Lynch’s move to imitate the low-cost on-line offer- to produce and deliver a product or service – that enables ings of its trading rivals, for example, risks undermining its a company to offer unique value. To be defensible, more- most precious advantage – its skilled brokers. And many over, the value chain must be highly integrated. When established companies, reacting to misguided investor a company’s activities fit together as a self-reinforcing enthusiasm, have hastily cobbled together Internet units system, any competitor wishing to imitate a strategy must in a mostly futile effort to boost their value in the stock replicate the whole system rather than copy just one or market. two discrete product features or ways of performing par- It did not have to be this way – and it does not have to ticular activities. (See the sidebar “The Six Principles of be in the future. When it comes to reinforcing a distinc- Strategic Positioning.”) tive strategy, tailoring activities, and enhancing fit, the Internet actually provides a better technological platform than previous generations of IT. Indeed, IT worked against The Absence of Strategy strategy in the past. Packaged software applications were Many of the pioneers of Internet business, both dot-coms hard to customize, and companies were often forced and established companies, have competed in ways that to change the way they conducted activities in order to violate nearly every precept of good strategy. Rather than conform to the “best practices”embedded in the software. focus on profits, they have sought to maximize revenue It was also extremely difficult to connect discrete appli- and market share at all costs, pursuing customers indis- cations to one another. Enterprise resource planning criminately through discounting, giveaways, promotions, (ERP) systems linked activities, but again companies were channel incentives, and heavy advertising. Rather than forced to adapt their ways of doing things to the software. concentrate on delivering real value that earns an attrac- As a result, IT has been a force for standardizing activities tive price from customers, they have pursued indirect rev- and speeding competitive convergence. enues from sources such as advertising and click-through Internet architecture, together with other improve- fees from Internet commerce partners. Rather than make ments in software architecture and development tools, trade-offs, they have rushed to offer every conceivable has turned IT into a far more powerful tool for strategy. product, service, or type of information. Rather than It is much easier to customize packaged Internet applica- tailor the value chain in a unique way, they have aped the tions to a company’s unique strategic positioning. By pro- activities of rivals. Rather than build and maintain control viding a common IT delivery platform across the value over proprietary assets and marketing channels, they chain, Internet architecture and standards also make it have entered into a rash of partnerships and outsourcing possible to build truly integrated and customized systems relationships, further eroding their own distinctiveness. that reinforce the fit among activities. (See the sidebar While it is true that some companies have avoided these “The Internet and the Value Chain.”) mistakes, they are exceptions to the rule. To gain these advantages, however, companies need to By ignoring strategy, many companies have under- stop their rush to adopt generic,“out of the box”packaged mined the structure of their industries, hastened compet- applications and instead tailor their deployment of Inter- itive convergence, and reduced the likelihood that they net technology to their particular strategies. Although it 72 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t remains more difficult to customize packaged applica- companies. A middleman with stocking locations all over tions, the very difficulty of the task contributes to the sus- the United States, Grainger would seem to be a textbook tainability of the resulting competitive advantage. case of an old-economy company set to be made obsolete by the Internet. But Grainger rejected the assumption that the Internet would undermine its strategy. Instead, The Internet as Complement it tightly coordinated its aggressive on-line efforts with its To capitalize on the Internet’s strategic potential, execu- traditional business. The results so far are revealing. Cus- tives and entrepreneurs alike will need to change their tomers who purchase on-line also continue to purchase points of view. It has been widely assumed that the Inter- through other means – Grainger estimates a 9% incre- net is cannibalistic, that it will replace all conventional mental growth in sales for customers who use the on-line ways of doing business and overturn all traditional ad- channel above the normalized sales of customers who vantages. That is a vast exaggeration. There is no doubt use only traditional means. Grainger, like Walgreens, has that real trade-offs can exist between Internet and tradi- also found that Web ordering increases the value of its tional activities. In the record industry, for example, on- physical locations. Like the buyers of prescription drugs, line music distribution may reduce the need for CD-man- the buyers of industrial supplies often need their orders ufacturing assets. Overall, however, the trade-offs are immediately. It is faster and cheaper for them to pick up modest in most industries. While the Internet will replace supplies at a local Grainger outlet than to wait for deliv- certain elements of industry value chains, the complete ery. Tightly integrating the site and stocking locations not cannibalization of the value chain will be exceedingly only increases the overall value to customers, it reduces rare. Even in the music business, many traditional activi- Grainger’s costs as well. It is inherently more efficient to ties – such as finding and promoting talented new artists, take and process orders over the Web than to use tradi- producing and recording music, and securing airplay–will tional methods, but more efficient to make bulk deliver- continue to be highly important. ies to a local stocking location than to ship individual or- The risk of channel conflict also appears to have been ders from a central warehouse. overstated. As on-line sales have become more common, Grainger has also found that its printed catalog bol- traditional channels that were initially skeptical of the sters its on-line operation. Many companies’ first instinct Internet have embraced it. Far from always cannibalizing is to eliminate printed catalogs once their content is those channels, Internet technology can expand op- portunities for many of them. The threat of disinter- mediation of channels appears considerably lower than initially predicted. Words for the Unwise: Frequently, in fact, Internet applications address activities that, while necessary, are not decisive in The Internet’s Destructive Lexicon competition, such as informing customers, process- ing transactions, and procuring inputs. Critical cor- The misguided approach to competition that characterizes business porate assets–skilled personnel, proprietary product on the Internet has even been embedded in the language used to technology, efficient logistical systems – remain in- discuss it. Instead of talking in terms of strategy and competitive ad- tact, and they are often strong enough to preserve vantage, dot-coms and other Internet players talk about “business existing competitive advantages. models.” This seemingly innocuous shift in terminology speaks In many cases, the Internet complements, rather volumes. The definition of a business model is murky at best. Most than cannibalizes, companies’ traditional activities often, it seems to refer to a loose conception of how a company and ways of competing. Consider Walgreens, the does business and generates revenue. Yet simply having a business most successful pharmacy chain in the United States. model is an exceedingly low bar to set for building a company. Gen- Walgreens introduced a Web site that provides cus- erating revenue is a far cry from creating economic value, and no tomers with extensive information and allows them business model can be evaluated independently of industry struc- to order prescriptions on-line. Far from cannibalizing ture. The business model approach to management becomes an the company’s stores, the Web site has underscored invitation for faulty thinking and self-delusion. their value. Fully 90% of customers who place orders Other words in the Internet lexicon also have unfortunate conse- over the Web prefer to pick up their prescriptions at quences. The terms “e-business” and “e-strategy” have been particu- a nearby store rather than have them shipped to larly problematic. By encouraging managers to view their Internet their homes. Walgreens has found that its extensive operations in isolation from the rest of the business, they can lead to network of stores remains a potent advantage, even simplistic approaches to competing using the Internet and increase as some ordering shifts to the Internet. the pressure for competitive imitation. Established companies fail Another good example is W.W. Grainger, a distrib- to integrate the Internet into their proven strategies and thus never harness their most important advantages. utor of maintenance products and spare parts to march 2001 73
  • S t rat e g y a n d t h e I n t e r n e t stages, each of which evolved out of con- The Internet and the Value Chain straints presented by the previous genera- tion. The earliest IT systems automated discrete transactions such as order entry The basic tool for understanding the vides a standardized infrastructure, an in- and accounting. The next stage involved influence of information technology on tuitive browser interface for information the fuller automation and functional en- companies is the value chain – the set access and delivery, bidirectional commu- hancement of individual activities such as of activities through which a product or nication, and ease of connectivity – all at human resource management, sales force service is created and delivered to cus- much lower cost than private networks operations, and product design. The third tomers. When a company competes in and electronic data interchange, or EDI. stage, which is being accelerated by the any industry, it performs a number of dis- Many of the most prominent applica- Internet, involves cross-activity integra- crete but interconnected value-creating tions of the Internet in the value chain tion, such as linking sales activities with activities, such as operating a sales force, are shown in the figure at right. Some order processing. Multiple activities are fabricating a component, or delivering involve moving physical activities on-line, being linked together through such tools products, and these activities have points while others involve making physical as customer relationship management of connection with the activities of suppli- activities more cost effective. (CRM), supply chain management (SCM), ers, channels, and customers. The value But for all its power, the Internet and enterprise resource planning (ERP) chain is a framework for identifying all does not represent a break from the past; systems. The fourth stage, which is just these activities and analyzing how they rather, it is the latest stage in the ongoing beginning, enables the integration of the affect both a company’s costs and the evolution of information technology.1 value chain and entire value system, that value delivered to buyers. Indeed, the technological possibilities is, the set of value chains in an entire Because every activity involves the available today derive not just from the industry, encompassing those of tiers of creation, processing, and communication Internet architecture but also from com- suppliers, channels, and customers. SCM of information, information technology plementary technological advances such and CRM are starting to merge, as end-to- has a pervasive influence on the value as scanning, object-oriented program- end applications involving customers, chain. The special advantage of the Inter- ming, relational databases, and wireless channels, and suppliers link orders to, for net is the ability to link one activity with communications. example, manufacturing, procurement, others and make real-time data created in To see how these technological and service delivery. Soon to be integrated one activity widely available, both within improvements will ultimately affect the is product development, which has been the company and with outside suppliers, value chain, some historical perspective largely separate. Complex product models channels, and customers. By incorporat- is illuminating.2 The evolution of infor- will be exchanged among parties, and In- ing a common, open set of communica- mation technology in business can be ternet procurement will move from stan- tion protocols, Internet technology pro- thought of in terms of five overlapping dard commodities to engineered items. replicated on-line. But Grainger continues to publish its In the prescription drug business, for example, mail orders catalog, and it has found that each time a new one is dis- represented only about 13% of all purchases in the late tributed, on-line orders surge. The catalog has proven to be 1990s. Even though on-line drugstores may draw more a good tool for promoting the Web site while continuing to customers than the mail-order channel, it is unlikely that be a convenient way of packaging information for buyers. they will supplant their physical counterparts. In some industries, the use of the Internet represents Virtual activities do not eliminate the need for physical only a modest shift from well-established practices. For activities, but often amplify their importance. The com- catalog retailers like Lands’ End, providers of electronic plementarity between Internet activities and traditional data interchange services like General Electric, direct activities arises for a number of reasons. First, introducing marketers like Geico and Vanguard, and many other Internet applications in one activity often places greater kinds of companies, Internet business looks much the demands on physical activities elsewhere in the value same as traditional business. In these industries, estab- chain. Direct ordering, for example, makes warehousing lished companies enjoy particularly important synergies and shipping more important. Second, using the Internet between their on-line and traditional operations, which in one activity can have systemic consequences, requiring make it especially difficult for dot-coms to compete. new or enhanced physical activities that are often unan- Examining segments of industries with characteristics ticipated. Internet-based job-posting services, for exam- similar to those supporting on-line businesses – in which ple, have greatly reduced the cost of reaching potential customers are willing to forgo personal service and im- job applicants, but they have also flooded employers with mediate delivery in order to gain convenience or lower electronic résumés. By making it easier for job seekers to prices, for instance–can also provide an important reality distribute résumés, the Internet forces employers to sort check in estimating the size of the Internet opportunity. through many more unsuitable candidates. The added 74 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t In the upcoming fifth stage, informa- ing, production, logistical, and servicing factors such as scale, the skills of person- tion technology will be used not only to transactions, the deeper levels of opti- nel, product and process technology, connect the various activities and players mization will involve the product design and investments in physical assets also in the value system but to optimize its itself. For example, product design will play prominent roles. The Internet is workings in real time. Choices will be be optimized and customized based on transformational in some respects, but made based on information from multi- input not only from factories and suppli- many traditional sources of competitive ple activities and corporate entities. Pro- ers but also from customers. advantage remain intact. duction decisions, for example, will auto- The power of the Internet in the value matically factor in the capacity available chain, however, must be kept in perspec- 1. See M.E. Porter and V.E. Millar,“How Informa- at multiple facilities and the inventory tive. While Internet applications have an tion Gives You Competitive Advantage,” (HBR July–August 1985) for a framework that helps available at multiple suppliers. While important influence on the cost and qual- put the Internet’s current influence in context. early fifth-stage applications will involve ity of activities, they are neither the only 2. This discussion is drawn from the author’s relatively simple optimization of sourc- nor the dominant influence. Conventional research with Philip Bligh. Prominent Applications of the Internet in the Value Chain Firm Infrastructure • Web-based, distributed financial and ERP systems • On-line investor relations (e.g., information dissemination, broadcast conference calls) Human Resource Management • Self-service personnel and benefits administration • Web-based training • Internet-based sharing and dissemination of company information • Electronic time and expense reporting Technology Development • Collaborative product design across locations and among multiple value-system participants • Knowledge directories accessible from all parts of the organization • Real-time access by R&D to on-line sales and service information Procurement • Internet-enabled demand planning; real-time available-to-promise/capable-to-promise and fulfillment • Other linkage of purchase, inventory, and forecasting systems with suppliers • Automated “requisition to pay” • Direct and indirect procurement via marketplaces, exchanges, auctions, and buyer-seller matching Inbound Logistics Operations Outbound Logistics Marketing and Sales After-Sales Service • Real-time integrated • Integrated information • Real-time transaction of • On-line sales channels • On-line support of scheduling, shipping, exchange, scheduling, orders whether initiated including Web sites and customer service repre- warehouse management, and decision making in by an end consumer, a marketplaces sentatives through e-mail demand management in-house plants, contract sales person, or a channel • Real-time inside and response management, and planning, and assemblers, and compo- partner outside access to customer billing integration, co- advanced planning and nents suppliers • Automated customer- information, product cata- browse, chat, “call me scheduling across the • Real-time available-to- specific agreements logs, dynamic pricing, now,” voice-over-IP and , company and its suppliers promise and capable- and contract terms inventory availability, other uses of video • Dissemination throughout to-promise information on-line submission of streaming • Customer and channel ac- the company of real-time available to the sales cess to product develop- quotes, and order entry • Customer self-service inbound and in-progress force and channels ment and delivery status • On-line product via Web sites and intelli- inventory data configurators gent service request • Collaborative integration processing including with customer forecasting • Customer-tailored market- updates to billing and systems ing via customer profiling shipping profiles • Integrated channel • Push advertising • Real-time field service management including • Tailored on-line access access to customer information exchange, • Real-time customer feed- account review, schematic warranty claims, and con- back through Web surveys, review, parts availability tract management (ver- opt-in/opt-out marketing, and ordering, work-order sioning, process control) and promotion response update, and service parts tracking management • Web-distributed supply chain management march 2001 75
  • S t rat e g y a n d t h e I n t e r n e t back-end costs, often for physical activities, can end up Traditional activities, often modified in some way, can outweighing the up-front savings. A similar dynamic compensate for these limits, just as the shortcomings of often plays out in digital marketplaces. Suppliers are able traditional methods – such as lack of real-time informa- to reduce the transactional cost of taking orders when tion, high cost of face-to-face interaction, and high cost they move on-line, but they often have to respond to of producing physical versions of information – can be many additional requests for information and quotes, offset by Internet methods. Frequently, in fact, an Inter- which, again, places new strains on traditional activities. net application and a traditional method benefit each Such systemic effects underscore the fact that Internet other. For example, many companies have found that applications are not stand-alone technologies; they must Web sites that supply product information and support be integrated into the overall value chain. direct ordering make traditional sales forces more, not Third, most Internet applications have some short- less, productive and valuable. The sales force can com- comings in comparison with conventional methods. pensate for the limits of the site by providing personal- While Internet technology can do many useful things ized advice and after-sales service, for instance. And the today and will surely improve in the future, it cannot do site can make the sales force more productive by auto- everything. Its limits include the following: mating the exchange of routine information and serving • Customers cannot physically examine, touch, and test as an efficient new conduit for leads. The fit between com- products or get hands-on help in using or repairing them. pany activities, a cornerstone of strategic positioning, • Knowledge transfer is restricted to codified knowledge, sacrificing the spontaneity and judgment that can result from interaction with skilled personnel. • The ability to learn about suppliers Strategic Imperatives for Dot-Coms and customers (beyond their mere and Established Companies purchasing habits) is limited by the lack of face-to-face contact. • The lack of human contact with the customer eliminates a power- At this critical juncture in the evolution names, which not only boosts margins ful tool for encouraging purchases, of Internet technology, dot-coms and es- but provides real differentiation. It is such trading off terms and conditions, tablished companies face different strate- new activities in the value chain, not providing advice and reassurance, gic imperatives. Dot-coms must develop minor differences in Web sites, that hold and closing deals. real strategies that create economic value. the key to whether dot-coms gain compet- • Delays are involved in navigating They must recognize that current ways itive advantages. AOL, the Internet pio- sites and finding information and of competing are destructive and futile neer, recognized these principles. It are introduced by the requirement and benefit neither themselves nor, in the charged for its services even in the face for direct shipment. end, customers. Established companies, of free competitors. And not resting on • Extra logistical costs are required in turn, must stop deploying the Internet initial advantages gained from its Web to assemble, pack, and move small on a stand-alone basis and instead use site and Internet technologies (such as shipments. it to enhance the distinctiveness of their instant messaging), it moved early to • Companies are unable to take ad- strategies. develop or acquire proprietary content. vantage of low-cost, nontransac- The most successful dot-coms will focus Yet dot-coms must not fall into the tional functions performed by sales on creating benefits that customers will trap of imitating established companies. forces, distribution channels, and pay for, rather than pursuing advertising Simply adding conventional activities is purchasing departments (such as and click-through revenues from third a me-too strategy that will not provide a parties. To be competitive, they will often competitive advantage. Instead, dot-coms performing limited service and need to widen their value chains to en- need to create strategies that involve new, maintenance functions at a cus- compass other activities besides those hybrid value chains, bringing together tomer site). conducted over the Internet and to de- virtual and physical activities in unique • The absence of physical facilities velop other assets, including physical configurations. For example, E*Trade is circumscribes some functions and ones. Many are already doing so. Some planning to install stand-alone kiosks, reduces a means to reinforce im- on-line retailers, for example, distributed which will not require full-time staffs, age and establish performance. paper catalogs for the 2000 holiday on the sites of some corporate customers. • Attracting new customers is diffi- season as an added convenience to their VirtualBank, an on-line bank, is cobrand- cult given the sheer magnitude of shoppers. Others are introducing propri- ing with corporations to create in-house the available information and buy- etary products under their own brand credit unions. Juniper, another on-line ing options. 76 harvard business review
  • S t rat e g y a n d t h e I n t e r n e t is in this way strengthened by the deployment of Internet instead of integrating the Internet into an overall strategy, technology. companies failed to capitalize on their traditional assets, Once managers begin to see the potential of the Inter- reinforced me-too competition, and accelerated competi- net as a complement rather than a cannibal, they will take tive convergence. Barnes & Noble’s decision to establish a very different approach to organizing their on-line ef- Barnesandnoble.com as a separate organization is a vivid forts. Many established companies, believing that the new example. It deterred the on-line store from capitalizing on economy operated under new rules, set up their Internet the many advantages provided by the network of physical operations in stand-alone units. Fear of cannibalization, it stores, thus playing into the hands of Amazon. was argued, would deter the mainstream organization Rather than being isolated, Internet technology should from deploying the Internet aggressively. A separate unit be the responsibility of mainstream units in all parts of was also helpful for investor relations, and it facilitated a company. With support from IT staff and outside con- IPOs, tracking stocks, and spin-offs, enabling companies sultants, companies should use the technology strategi- to tap into the market’s appetite for Internet ventures cally to enhance service, increase efficiency, and leverage and provide special incentives to attract Internet talent. existing strengths. While separate units may be appropri- But organizational separation, while understandable, ate in some circumstances, everyone in the organization has often undermined companies’ ability to gain compet- must have an incentive to share in the success of Internet itive advantages. By creating separate Internet strategies deployment. bank, allows customers to deposit checks at Established companies, for the most ing. Target customers include retirees and Mail Box Etc. locations. While none of these part, need not be afraid of the Internet – small-business owners. Edward Jones does approaches is certain to be successful, the the predictions of their demise at the not offer commodities, futures, options, or strategic thinking behind them is sound. hands of dot-coms were greatly exagger- other risky forms of investment. Instead, Another strategy for dot-coms is to seek ated. Established companies possess tradi- the company stresses a buy-and-hold out trade-offs, concentrating exclusively on tional competitive advantages that will approach to investing involving mutual segments where an Internet-only model often continue to prevail; they also have funds, bonds, and blue-chip equities. offers real advantages. Instead of attempt- inherent strengths in deploying Internet Edward Jones operates a network of about ing to force the Internet model on the technology. 7,000 small offices, which are located con- entire market, dot-coms can pursue cus- The greatest threat to an established veniently to customers and are designed tomers that do not have a strong need for company lies in either failing to deploy to encourage personal relationships with functions delivered outside the Internet – the Internet or failing to deploy it strategi- brokers. even if such customers represent only a cally. Every company needs an aggressive Edward Jones has embraced the Inter- modest portion of the overall industry. program to deploy the Internet through- net for internal management functions, In such segments, the challenge will be to out its value chain, using the technology to recruiting (25% of all job inquiries come find a value proposition for the company reinforce traditional competitive advan- via the Internet), and for providing that will distinguish it from other Internet tages and complement existing ways of account statements and other information rivals and address low entry barriers. competing. The key is not to imitate rivals to customers. However, it has no plan to Successful dot-coms will share the but to tailor Internet applications to a offer on-line trading, as its competitors do. following characteristics: company’s overall strategy in ways that Self-directed, on-line trading does not fit • Strong capabilities in Internet technology extend its competitive advantages and Jones’s strategy nor the value it aims to • A distinctive strategy vis-à-vis make them more sustainable. Schwab’s deliver to its customers. Jones, then, has established companies and other expansion of its brick-and-mortar branches tailored the use of the Internet to its dot-coms, resting on a clear focus and by one-third since it started on-line trad- strategy rather than imitated rivals. The meaningful advantages ing, for example, is extending its advan- company is thriving, outperforming rivals • Emphasis on creating customer value tages over Internet-only competitors. The whose me-too Internet deployments have and charging for it directly, rather than Internet, when used properly, can support reduced their distinctiveness. relying on ancillary forms of revenue greater strategic focus and a more tightly The established companies that will • Distinctive ways of performing physical integrated activity system. be most successful will be those that use functions and assembling non-Internet Edward Jones, a leading brokerage firm, Internet technology to make traditional assets that complement their strategic is a good example of tailoring the Internet activities better and those that find and positions to strategy. Its strategy is to provide con- implement new combinations of virtual • Deep industry knowledge to allow servative, personalized advice to investors and physical activities that were not proprietary skills, information, and who value asset preservation and seek previously possible. relationships to be established trusted, individualized guidance in invest- march 2001 77
  • S t rat e g y a n d t h e I n t e r n e t The End of the New Economy succeed by concentrating on market segments that ex- hibit real trade-offs between Internet and traditional The Internet, then, is often not disruptive to existing in- methods–either those in which a pure Internet approach dustries or established companies. It rarely nullifies the best meets the needs of a particular set of customers or most important sources of competitive advantage in an those in which a particular product or service can be best industry; in many cases it actually makes those sources delivered without the need for physical assets. (See the even more important. As all companies come to embrace sidebar “Strategic Imperatives for Dot-Coms and Estab- Internet technology, moreover, the Internet itself will be lished Companies.”) neutralized as a source of advantage. Basic Internet ap- These principles are already manifesting themselves in plications will become table stakes–companies will not be many industries, as traditional leaders reassert their able to survive without them, but they will not gain any strengths and dot-coms adopt more focused strategies. advantage from them. The more robust competitive ad- In the brokerage industry, Charles Schwab has gained vantages will arise instead from traditional strengths such a larger share (18% at the end of 1999) of on-line trading as unique products, proprietary content, distinctive phys- than E-Trade (15%). In commercial banking, established ical activities, superior product knowledge, and strong institutions like Wells Fargo, Citibank, and Fleet have personal service and relationships. Internet technology many more on-line accounts than Internet banks do. Es- may be able to fortify those advantages, by tying a com- tablished companies are also gaining dominance over In- pany’s activities together in a more distinctive system, ternet activities in such areas as retailing, financial infor- but it is unlikely to supplant them. mation, and digital marketplaces. The most promising Ultimately, strategies that integrate the Internet and dot-coms are leveraging their distinctive skills to provide traditional competitive advantages and ways of compet- real value to their customers. ECollege, for example, is a ing should win in many industries. On the demand side, full-service provider that works with universities to put most buyers will value a combination of on-line services, their courses on the Internet and operate the required de- personal services, and physical locations over stand-alone livery network for a fee. It is vastly more successful than Web distribution. They will want a choice of channels, competitors offering free sites to universities under their delivery options, and ways of dealing with companies. own brand names, hoping to collect advertising fees and On the supply side, production and procurement will be other ancillary revenue. more effective if they involve a combination of Internet When seen in this light, the “new economy” appears and traditional methods, tailored to strategy. For example, less like a new economy than like an old economy that customized, engineered inputs will be bought directly, has access to a new technology. Even the phrases “new facilitated by Internet tools. Commodity items may be economy” and “old economy” are rapidly losing their rel- purchased via digital markets, but purchasing experts, evance, if they ever had any. The old economy of estab- supplier sales forces, and stocking locations will often also lished companies and the new economy of dot-coms are provide useful, value-added services. merging, and it will soon be difficult to distinguish them. The value of integrating traditional and Internet meth- Retiring these phrases can only be healthy because it will ods creates potential advantages for established compa- reduce the confusion and muddy thinking that have been nies. It will be easier for them to adopt and integrate In- so destructive of economic value during the Internet’s ternet methods than for dot-coms to adopt and integrate adolescent years. traditional ones. It is not enough, however, just to graft In our quest to see how the Internet is different, we the Internet onto historical ways of competing in sim- have failed to see how the Internet is the same. While a plistic “clicks-and-mortar” configurations. Established new means of conducting business has become available, companies will be most successful when they deploy In- the fundamentals of competition remain unchanged. The ternet technology to reconfigure traditional activities or next stage of the Internet’s evolution will involve a shift when they find new combinations of Internet and tradi- in thinking from e-business to business, from e-strategy to tional approaches. strategy. Only by integrating the Internet into overall Dot-coms, first and foremost, must pursue their own strategy will this powerful new technology become an distinctive strategies, rather than emulate one another or equally powerful force for competitive advantage. the positioning of established companies. They will have to break away from competing solely on price and instead The author is grateful to Jeffrey Rayport and to the Advanced focus on product selection, product design, service, image, Research Group at Inforte for their contributions to this article. and other areas in which they can differentiate them- selves. Dot-coms can also drive the combination of Inter- Reprint r0103d net and traditional methods. Some will succeed by creat- To place an order, call 1-800-988-0886. ing their own distinctive ways of doing so. Others will 78 harvard business review