STRATEGY & THE INTERNET

STRATEGY &THE INTERNET A review of the article by Michael E. Porter presented by Group 4 – October 24, 2010

THE AUTHOR – MICHAEL E. PORTER • Born in Ann Arbor, Michigan • Son of a career Army officer • Served through the rank of captain in the U.S. Army Reserve • B.S.E. with high honors in aerospace and mechanical engineering from Princeton University in 1969 • M.B.A. with high distinction in 1971 from the Harvard Business School • Ph.D. in Business Economics from Harvard University in 1973 • George F. Baker Scholar

THE AUTHOR – MICHAEL E. PORTER • Leading authority on competitive strategy, the competitiveness and economic development of nations, states, and regions, and the application of competitive principles to social problems such as health care, the environment, and corporate responsibility. • Bishop William Lawrence University Professor, based at Harvard Business School • Institute for Strategy and Competitiveness

THE AUTHOR – MICHAEL E. PORTER • Author of 18 books and over 125 articles • Competitive Strategy: Techniques for Analyzing Industries and Competitors • Competitive Advantage: Creating and Sustaining Superior Performance (1985) • The Competitive Advantage of Nations (1990) • Can Japan Compete? (2000) • On Competition (2008)

THE AUTHOR – MICHAEL E. PORTER • McKinsey Award 1st Place Winner (2001) for Strategy & the Internet article • Developed and chairs the New CEO Workshop, a Harvard Business School program for newly appointed CEOs of the world’s largest and more complex corporations

Strategy and The Internet • The internet is a powerful set of tools that can be used, wisely or unwisely, in almost any industry and as part of almost any strategy. • The internet is not a tool that can support the firm’s strategic position. • It weakens industries profitability, as rivals compete on price only. • It no longer provides proprietary advantage because all companies use the web. • Integrating Internet advantage is that it enhances the company’s ability to develop unique products, proprietary content, distinctive processes, and strong personal service to create true value, and that have always defined competitive advantage.

Strategy and The Internet • If a company integrates internet into its overall strategy and operations so that they can • complement, rather than cannibalize, your established competitive approaches and • create systemic advantages that your competitors can’t copy. • The key question is not whether to deploy Internet technology. The question is how to deploy it. • The internet tends to alter industry structures in ways that reduce overall profitability, and it has a leveling effect on business practices, reducing the ability of any company to establish an operational advantage that can be sustained. • The Internet makes strategy more essential than ever.

Distorted Market Signals • Companies that have deployed internet technology should be careful about market signals. • The companies can be confused by distorted market signals because those signals can be unreliable. • In the early stage of a new technology, new experiments are attractive for both companies and customers. But an experimentation is economically unsustainable. • Sales figures are unreliable for three reasons: • Many firms subsidize the purchase of their product and services. Buyers can purchase the products at heavy discounts. • Curiosity. Why not try it as an experiment? • Received “revenues” from on-line commerce in the form of stock rather than cash.

Distorted Market Signals • Supplier practices have artificially depressed the costs of doing business on the Internet, making it appear more attractive than it really is. • Signals from the stock market are more unreliable. • The true financial performance of many internet-related businesses is unreliable too because of distorted revenues, costs, and share prices. • The increasing number of dot-coms is a danger sign.

A return to Fundamentals • The creation of true economic value becomes the final arbiter of business success. • Revenue, expense and stock price are not sufficient • Economic value for a company is the gap between price and cost. • Uses of internet create economic value. • How the internet can be used to create economic value? • industry structure, which determines theprofitability of the average competitor; and • sustainable competitive advantage, which allows a company to outperform the averagecompetitor.

Internet and Industry Structure • Internet creates new digital marketplace. • Business-to-Business & Business-to-Consumers • Internet has positive and negative impacts on industries • Porter’s Five Forces help to determine the economic value created by the Internet • Barriers to Entry • Bargaining Power of Buyers • Bargaining Power of Suppliers • Threat of Substitutes • Degree of the Rivalry 7

Porter’s Five Forces & Industry • Barriers to Entry • Internet decreases the barriers to entry • Reduces the needs of sales force, physical assets • Many new players enter industries • Avoid the geographical barriers • BlockBuster vs. Netflix • Bargaining Power of Suppliers • Internet procurement and digital markets provide all companies equal access to suppliers • Suppliers directly reach consumers • Suppliers become more powerful. 8

Porter’s Five Forces & Industry (cont.) • Bargaining Power of Buyers • Eliminate some distribution channels, decrease distribution cost • Internet increases the power of buyers • Consumers reach many companies from the Internet • Product options are available • Direct Automobile Dealers vs. Online dealers • Threats of Substitutes • Expand the market size • Proliferation of the Internet increases threats of substitutes • Online auction 9

Porter’s Five Forces & Industry (cont.) • Degree of Rivalry • Internet makes price competition more tough for the industry players • Avoid the geographic barriers, so it increases number of competitors • Reduce difference between competitors offerings • Low switching cost increases rivalry • E-bay vs. Amazon 10

The Myth of the First Mover • Deployment of the Internet increase switching cost • First Movers have competitive advantage • Users get familiar with the company’s website interface • Some software programs compatible with most websites, so it reduces switching cost • Networks Effects: products or services become more valuable as more customers use them • Creating network effects requires large amount of investment • Partnering: complements &outsourcing 11

E-mail Market Share 12

The Internet and Competitive Advantage The only ways to achieve a sustainable competitive advantage is by: • Operating at a lower price • Commanding a premium price • Doing both

Ways to Achieve Cost and Price Advantages • Operational Effectiveness • Doing the same things your competitors do but doing them better • Strategic Positioning • Doing things differently than your competitors in order to deliver a unique type of value to customers

Internet Improves Operational Effectiveness Advantages Disadvantages Makes it difficult to sustain advantages because it is easy for rivals to copy. Provides the ability for many companies to end up doing the same thing in the same way. May end in customers making decisions based on prices because of lack of differentiation. • Enhances the exchange of real-time information. This enables improvements throughout the value chain for almost every company & industry. • Is an open platform with common standards. It provides benefits with much less investment than the information technology of the past.

Six Principles of Strategic Positioning • Start with the right goal: superior long-term return on investment. • A company’s strategy must enable it to deliver a value proposition, or set of benefits, different from those that competitors offer. • Strategies need to be reflected in a distinctive value chain- either different activities than rivals or same activities in different ways. • Robust strategies involve trade-offs. • Strategy defines how all the elements of what a company does fit together. • Strategy involves continuity of direction.

The Internet and the Value Chain • The value chain is the set of activities through which a product or service is created & delivered to customers. • Every activity of the value chain is affected by the Internet. • The Internet links the activities and makes real-time data available to all participants. • The Internet is part of an ongoing evolution of information technology. • Although the Internet affects all parts of the value chain, many traditional sources of competitive advantage still remain.

“The winners will be those that view the Internet as a complement to, not a cannibal of traditional ways of competing.” –Michael Porter

The Absence of Strategy • Many of the pioneers of Internet business have competed in ways that violate nearly every precept of good strategy • Rather than focus on profits, sought to maximize revenue and market share at all costs • Rather than concentrate on delivering real value, have pursued indirect revenues from sources such as advertising and click-through fees • Rather than tailor the value chain in a unique way, have imitated the activities of rivals • Rather than build and maintain control over proprietary assets and marketing channels, they have entered into a rash of partnerships and outsourcing relationships, further eroding their own distinctiveness.

The Absence of Strategy • Ignoring good business strategy • Undermines structure of industry • Hastens competitive convergence • Reduces likelihood of anyone developing a competitive advantage • Price becomes only competitive variable • Companies have turned competition into a race to the bottom.

Lessons Learned • When it comes to reinforcing a distinctive strategy, tailoring activities, and enhancing fit, the internet actually provides a better technological platform than previous generations of IT. • Companies need to stop their rush to adopt generic, “out of the box” packaged applications and instead tailor their deployment of Internet technology to their particular strategies.

The Internet as Complement • Widely assumed that the Internet is cannibalistic, that it will replace all conventional ways of doing business and overturn all traditional advantages • Tradeoffs are modest in most industries (online music reducing need for CDs) • True that the Internet will replace certain elements, complete cannibalization of the value chain will be exceedingly rare • Finding new talent and recording music will still be very important to the music industry • Critical Corporate assets – skilled personnel, proprietary product technology, efficient logistical systems – remain intact, and they are often strong enough to preserve competitive advantages.

The Internet as Complement • Walgreen's – Most successful pharmacy chain • Developed website that offer’s customers extensive information and allows them to order their prescriptions online. • 90% of customers who place prescription orders online prefer to pick-up in store. • Vast network of stores and online ordering complement each other to produce value for the customer.

The Internet as Complement • W.W. Grainger – Distributor of Maintenance Products • Rejected assumption that Internet would undermine its strategy • Tightly integrating the website and stocking locations not only increases the overall value to customers, it reduces Grainger’s costs as well • Saves customers time and money wasted on shipping • Saves Grainger money by being able to ship in bulk to stocking locations, instead of individually to customer • Grainger found that its print catalog bolsters its on-line operation • Each time a new catalog is distributed, on-line orders surge

The Internet as a Complement • Virtual activities do not eliminate the need of physical activities, but often amplify their importance • Internet application in one activity often increases demand for physical activities elsewhere (i.e. online orders increase need for shipping and warehousing) • Using the Internet can have systematic consequences, requiring new or enhanced physical activities that are often unanticipated (i.e. online job postings websites) • Internet applications have some shortcomings when compared to conventional methods • No hands-on interaction with product • Limited knowledge available • No human contact (recommendations, problem-solving) • Extra logistical costs

SUPPORTING ARTICLES First-Mover Advantage for Internet Startups: Myth or Reality? (2002, Sydney Finkelstein) • Easy to create web presence • Brand recognition barrier to entry • Market: online companies v. existing companies • Switching costs • Difficulty protecting competitive position • Majority of entrants in commodity markets “We’ve been doing it longer – it takes a long time to get this business right. They can’t catch us.” —eToys Senior Manager re: ToysRUs

SUPPORTING ARTICLES • The Effect of Market Leadership in Business Process Innovation: The Case(s) of E-Business Adoption (August 2010, Kristina McElheran) • Analyzed 1999 U.S. Census data of approximately 35,000 plants in 86 U.S. manufacturing industries • Investigating relationship between market leadership and the adoption of new technologies to maintain or gain competitive advantage • Findings: • Market leaders were more likely than small entrants to adopt incremental business process innovations. • Market leaders were less likely than small entrants to adopt radical business process innovations.

TOP E-TAILERS BY SALES VOLUME Lamb, Charles W., Joseph F. Hair, and Carl McDaniel, MKTG4, 2011 Edition, Ohio: Cengage Learning (South-Western).

SATISFACTION vs. PURCHASE INTENT Spring 2010 Online Retail Satisfaction Index, ForeSeeResults.com.

SATISFACTION BY PRODUCT CATEGORY Freed, Larry, Spring 2010 Online Retail Satisfaction Index, ForeSeeResults.com.

NETFLIX SUCCESS • Target a specific niche: When there's an ache, you want to be like aspirin, not vitamins. Aspirin solves a very particular problem someone has, whereas vitamins are a general "nice to have" market. [The Netflix idea] was certainly aspirin. • Stay flexible: We named the company Netflix (NFLX), not DVDs by Mail because we knew that eventually we would deliver movies directly over the Internet. DVDs will be around a long time, but we're building for the day when they're not.

NETFLIX SUCCESS • Never underestimate the competition: We erroneously concluded that Blockbuster (BBI, Fortune 500) probably wasn't going to launch a competitive effort when they hadn't by 2003. Then, in 2004, they did. We thought, Well, they won't put much money behind it. Over the past four years they've invested more than $500 million against us. • There are no shortcuts: Occasionally great wealth is created in a short amount of time, but it's through a lot of luck in those situations. You just have to think of building an organization as a lot of work. It may or may not turn into great wealth.

SOURCES • Finkelstein, Sydney. "First-Mover Advantage for Internet Startups: Myth or Reality?” Adapted from: Handbook of Business Strategy 3 (2002): pgs. 39-46. October 23, 2010 http://mba.tuck.dartmouth.edu/pages/faculty/syd.finkelstein/articles/First_Mover.pdf . • Harvard Business School. Faculty & Research: Michael E. Porter - Bishop William Lawrence University Professor. Date of Last Revision September 2008. Accessed October 23, 2010. http://drfd.hbs.edu/fit/public/facultyInfo.do?facInfo=bio&facId=6532. • McElheran, Kristina Steffenson. "The Effect of Market Leadership in Business Process Innovation: The Case(s) of E-Business Adoption." Harvard Business School Working Paper, No. 10-104, June 2010. http://www.hbs.edu/research/pdf/10-104.pdf . • “Winners 2001: McKinsey Awards.” Harvard Business Review. 2001: page 102. Accessed October 23, 2010. http://www.isc.hbs.edu/mckinsey.pdf

STRATEGY & THE INTERNET