NBA 600: Session 4 Strategy and the Internet 30 January 2003

1. NBA 600: Session 4Strategy and the Internet 30 January 2003 Daniel Huttenlocher

2. Today’s Class • Analysis and discussion of Porter-Tapscott “debate” on Strategy and Internet • Changes in competitive landscape • Strategy more important not less • Consider some of the changes • Business models also more important • Mediate technology development and value creation (Chesbrough) • Increases importance in time of large change • Discuss some business models and new technologies

3. Analysis of Porter-Tapscott • Agree on some terminology • Strategy: being profitable by choosing what to do and what not to do • Consistent direction; not all things to all people • Based on analyzing structure of industry • Competitors, suppliers, customers, new entrants, substitutes • Business model: where profitable revenue is going to come from • Who will pay, for what, when, why, how much? • Operations: doing better at what doing • Industry-wide best practices

4. Internet Changes Landscape • Increases need for strategy • Increases bargaining power of customers • Can decrease bargaining power of suppliers • Either lowers or raises switching costs • Change to substitutes generally easier, except where strong enough “network effects” • Less clear general effects on barriers to entry or competitors • Creates need to consider business models • May enable new sources of revenue or undermine current sources

5. First Mover Myth • Being there first does not alone provide much advantage • E.g., Priceline was early in online travel • But its model has had only niche appeal • Even for business with network effects • Where customers benefit from a single product or service (e.g., computer software) • Though eBay and Internet Chess club are examples of first-mover plus network effect • Good strategy and execution count a lot • Provide what customer wants, deliver more effectively

6. Expedia Not First to Travel Market • Now a leading player – and profitable • E.g., 20x travel sales of Priceline • Good execution

7. First Mover: IT Beyond Internet • Betamax vs. VHS videotape formats • Huge network effect for rental market • Started as on-air recording business; shifted • Sony’s go-it-alone strategy lost to consortium • Microsoft repeated late-entrant dominance • Network effects of software • DOS vs. CPM, Windows vs. Mac or OS/2, IE vs. Netscape, Excel vs. 123, Word vs. Wordperfect/ Winstar, … • HP dominance of laser printer market • Invented by Xerox but didn’t want to undercut high end printing business

8. Internet and Bargaining Power • Provides vastly improved ability to search and compare • Uncensored public opinion • Advertising and product descriptions • Discounted pricing and price comparison • Empowers purchasers • Both consumers and companies • Tilts balance so that vendors become weaker and customers become stronger • Exceptions where effective monopolies

9. Internet and Industry Structure • Fundamental changes to any content creation or distribution business • Music, movies, telephone, broadcasting, … • Digital content opens totally new means of distribution and protection • Technologically possible to control the experience of the content after purchase • E.g., force watching previews on DVD’s • Expert users able to circumvent controls • Possibility of unfettered illicit copying • Raging battle over degree of control

10. Internet Substitutes • Classified ads major source of revenue for newspaper industry (about $20B/yr) • Web provides substitute for classifieds • Arguably better once credible • What is happening, where might it end up • Collectibles already have moved to eBay • But low revenue for newspapers (not for eBay!) • Employment moving to Monster, Yahoo • Perhaps not yet replacing, but high revenue risk • Real estate still strong, but online just starting • Major revenue source

11. Substitutes: Online vs. Offline • Book sales • Amazon dominates the online market • Borders strategy is to supplement stores • Outsourced online sales to Amazon • Prominent link to stores site • Provide access to store inventory • Competitive advantages and disadvantages • What decisions do prospective customers make? • With respect to both online and offline competitors • Barnes and Noble separates businesses • Only offer online directions and in store returns

12. Internet and Outsourcing • Contract manufacturing • Has become a large business • Top 5 over $50B annual revenue • Requires close interaction, facilitated by Internet • Outsourcing of operations functions • Travel, benefits management done on Web • Joint sales • IBM has been champion in this regard • Solutions and business bundles hardware, software, services • Joint selling with other vendors

13. Importance of Business Models • Telling a good story (Magretta) • Answering Drucker’s age-old questions: • Who is the customer? What do they value? • Addressing fundamental economics: • How do we make money? What is the underlying logic that explains it? • Travelers checks as example • Letters of credit cumbersome, cash dangerous • Make money on “float” and non-redemption • Information business • This person is good for the money • Until global information networks (ATM, credit)

14. Business Models are Not Strategy • Often used interchangeably but wrong • Business model: how to profitably generate value for the customer • Omits the critical dimension of competition • Which comes not only from competitors but also from suppliers, customers, substitutes, entrants • Competitive strategy explains how will do better than rivals – what advantage • First mover is not enough • Business model mediates between value creation and new technology (Chesbrough)

15. Business Models and IT • Information independent of physical form • New physical, electronic or other forms can completely change transmission of information • And its value – which can be due to rarity • Different from physical goods and “human services” • New information technologies can enable different forms of information transmission • Undercut old forms and their value • Introduce new ones with new profitability • Fertile ground for new business models

16. Some History of IT Business Models • Radio broadcasting – needed new model • Subscription or fee not possible model • In contrast to newspapers, magazines, movies • Promising new technology • Stock bubble (1905-1910) • Big business by 1920’s • Many broadcasters were manufacturers • Westinghouse, RCA • Evolution of national radio networks • Eventually audience for sponsors/advertisers • TV broadcasting – adopted TV model • Initial losses absorbed by radio broadcasters

17. IT Manufacturers • Often explicitly create product need through content/services • Radio equipment manufacturers developed broadcasts to drive demand for radio sets • Motorola creates businesses to drive demand • Built early pager and cellular networks • Exited service businesses once critical mass • Satellite phone networks (e.g., Iridium) were costly businesses that never yielded demand • Intel’s VC arm invests in applications that create need for faster microprocessors • Positive returns generate more value

18. Copying Written Information • Haloid (Xerox) introduced 914 in 1959 • First plain paper copier; substitute for existing technologies that did not produce typed quality • Prevailing business model “razor & blades” • Slight markup over cost on equipment • Typical machine sold for around $300 • Higher markup on consumables (special paper and supplies) • On average used for 15-20 copies per day • Business model a problem for Haloid • Manufacturing cost of 914 around $2000 • Although per copy costs similar to others

19. A (Revolutionary) New Model • Nobody could see how to make money with this new technology • Haloid tried to get Kodak, GE and IBM to help market the 914 but all thought no business • AD Little concluded device was highly versatile but had no future in office copying market • Joe Wilson bet that there was greater “latent” value in the technology • Leased the device at $95/mo including 2,000 copies, $.04 per additional copy • Without extra copies, about 2 years to reach profitability on each lease

20. Wildly Successful Model • Once installed, the 914’s generated an average of 2,000 copies/day (not month) • Almost 20x the lease revenue • Xerox compound growth rates 41%/yr for twelve years • $2.5 billion revenue and high margins by 1972 • Never would have gotten off the ground without a new business model – leasing • Unfortunately Xerox had too hard a time getting past the “lease plus click” model • Lost low-end business to HP, “razor & blades”

21. Summing Up • Importance of Internet to strategy • Changes to industry structure require strategic analysis that accounts for effects • Internet does change the rules in many industries • Changes well handled by strategic analysis • Customers, suppliers, competitors, substitutes, new entrants • First mover advantage does not exist • Explicit consideration of business models is more important in “information age”

22. Next Week • Direct customer access to information • Airline reservation systems • Travel agent as customer • Web reservation systems, traveler as customer • Packing tracking systems • Dell direct – phone and online • Operational “versus” strategic information systems • SABRE evolving from operational to strategic • Fedex recognizing both competitive advantage and operational efficiency