NBA 600: Session 4Strategy and the Internet

30 January 2003

Daniel Huttenlocher

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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

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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

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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

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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

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Expedia Not First to Travel Market

Now a leading player – and profitable– E.g., 20x travel sales of Priceline– Good execution

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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

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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

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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

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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

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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

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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

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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)

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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)

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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

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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

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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

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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

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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

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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”

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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”

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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