Strategy and the Internet: The New Learningosservatori.sdabocconi.it/bfa/file/porter.pdf · Determinants of Relative Performance Types of Competitive Advantage ... Michael E. Porter

Strategy and the Internet:The New Learning

Professor Michael E. PorterHarvard Business School

PTC PresentationBocconi University, Milan

December 3, 2001

This presentation draws on ideas from Professor Porter’s books, in particular, Competitive Strategy (The Free Press, 1980),Competitive Advantage (The Free Press, 1985), “What is Strategy?” (Harvard Business Review, Nov/Dec 1996), “Strategy andthe Internet” (Harvard Business Review, March 2001). and a forthcoming book. No part of this publication may be reproduced,stored in a retrieval system, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, orotherwise - without the permission of Michael E. Porter.

2 Copyright 2001 © Professor Michael E. PorterPTC Strategy and Internet PINEHURST - 10-30-01 CK

The Fundamentals of Competitive StrategySetting the Right Goals

• The creation of economic value depends on the ability to produce goodsand services that command prices greater than their full costs

• The central goal of a firm must be superior long-term return oninvestment

• Other goals and metrics (e.g. eps growth; pro-forma operating cashflow) carry grave risks for strategy

• Prevalent accounting adjustments to reported profitability tend toobscure true economic performance

• Current shareholder value should not drive strategy directly.Sustainable shareholder value depends on economic value


The Fundamentals of Competitive StrategyDeterminants of Profitability

• The fundamental unit of strategic analysis is the industry

• Company economic performance results from two distinct causes:

• Strategy must encompass both

IndustryStructureIndustryIndustryStructureStructure

Relative Position Within the

Industry

Relative Position Relative Position Within the Within the

IndustryIndustry

- Rules of Competition - Sources of Competitive Advantage


Determinants of Relative PerformanceTypes of Competitive Advantage

Differentiation(Non-Price Value)

Lower Cost

CompetitiveAdvantage

CompetitiveAdvantage


Marketing& Sales

(e.g. SalesForce,

Promotion,Advertising,

ProposalWriting, Web

site)

• Companies are collections of discrete activities, in whichcompetitive advantage resides

InboundLogistics

(e.g. IncomingMaterial

Storage, DataCollection,

Service,CustomerAccess)

Operations

(e.g.Assembly,

ComponentFabrication,

BranchOperations)

OutboundLogistics

(e.g. OrderProcessing,

Warehousing,Report

Preparation)

After-SalesService

(e.g. Installation,CustomerSupport,

ComplaintResolution,

Repair)

M

a

rg

i

n

Primary Activities

SupportActivities

Firm Infrastructure(e.g. Financing, Planning, Investor Relations)

Procurement(e.g. Components, Machinery, Advertising, Services)

Technology Development(e.g. Product Design, Testing, Process Design, Material Research, Market Research)

Human Resource Management(e.g. Recruiting, Training, Compensation System)

Competitive Advantage and Activities

Value

Whatbuyers arewilling topay


Determinants of Relative Performance

• Creating a unique andsustainable competitiveposition

• Assimilating, attaining, andextending best practice

OperationalOperationalEffectivenessEffectiveness

Do the same thing better Compete in a different way

StrategicStrategicPositioningPositioning


Creating a Strategic PositionNeutrogena Soap

Mix of Value• Mild, residue-free soap formulated for pH

balance

Activities• Eleven ingredient formulation to minimize skin

irritants

• Two-layered packaging• Slow, controlled molding process• Distribution only through drugstores or the

drug section of combination stores

• Premium price• No/few price promotions• Detailing to the medical community

• Attendance at dermatology conferences• Fact-based consumer ads• Advertise in medical journals

• Advanced skin care research (NeutrogenaSkinCare Institute)


Tests of the Existence of a Strategy

• Different value proposition / desired mix of value

• Different value chain


• Superior-engineered, high performance,sporty automobiles

• “Active driving” design philosophy

• Highly unique product and engineperformance

• Centralized engineering

• Long product design cycle

• Extreme customization of customer orders

• High craft labor input in production withselective automation

• High vertical integration to achieveproprietary components

• One global brand

• Limited dealer system

• Non-traditional, brand-focused marketing

• BMW-sponsored race team

Positioning: Variety-BasedBMW

ParticularParticularProduct VarietyProduct Variety

Set ofSet ofActivitiesActivities

Source: Draws on research conducted by Harvard Business School students M. Collardin, F. Cueto, J. Encinar, A. Gonzalez, A. Kulyk, and D. Smith, April 1997


Sustaining a Competitive Position Requires Tradeoffs

• Choosing a unique position is necessary but not sufficient to createa sustainable advantage because of the threat of imitation

• Imitation takes two forms:

– Repositioning

– Straddling

• Traditional thinking focuses on competitors’ ability to imitate

• Equally, if not more important, is whether competitors want to imitate

• Tradeoffs are incompatibilities between positions that create theneed for choice

• Strategic tradeoffs lie at the heart of sustainability


Strategic TradeoffsNeutrogena Soap

• Forgo cleaning, skin softening, anddeodorizing features

• Bear higher costs through the configuration of:

– manufacturing

– detailing

– medical advertising

– skin research

• Forgo the ability to reach customers via:

– price promotions

– television

– some distribution channels


Recent Thinking on the Sources of Competitive Advantage

• “Core” Competencies

• “Critical” Resources

• “Key” Success Factors

• “Core” Competencies

• “Critical” Resources

• “Key” Success Factors


Southwest Airlines Activity System

LimitedPassenger

Service

Short-haul, point-to-point routes

between medium-sized cities and

secondaryairports

Very LowTicket Prices

Lean, HighlyProductive

Ground and GateCrews

Frequent,Reliable

Departures

HighAircraft

Utilization

15-MinuteGateTurns

AutomaticTicketingMachines

Standardizedfleet of 737

aircraft

Limited useof travelagents

Highemployee

compensation

Flexibleunion

contracts

Highemployee

stockownership

No seatassignments

No mealsNo

baggagetransfers

Noconnectionswith other

airlines

“Southwest,the low-fare

airline”


Zara Activity System

Source: Draws on research by Jorge Lopez Ramon (IESE)at the Institute for Strategy and Competitiveness, HBS

Veryflexible

productionsystemOwnership

ofproduction

sites

Use ofadvanced

textilemachinery

JITdelivery

Encouragerepeatbuyers

Primestore

locations

Veryfrequentproductchanges

Fashion atmoderateprice and

quality

Extensiveuse ofstore

sales data

Word-of-Mouth

Marketing

No mediaadvertising

Widelypopularstyles

Globalteam oftrend-

spotters

Production inSpain &

Portugal, closeto markets


Strategic Continuity and Continuous Improvement

• A strategy is not fixed, but a direction the company is following

• Continuity of strategy contributes strongly to sustainable competitiveadvantage

- e.g., organizational understanding of the strategy

- clear identity with customers, channels, and other outside entities

- time to build truly unique skills and assets related to the strategy

- enhance fit

• Strategic continuity and continuous change should occursimultaneously. They are not inconsistent

• Continuity of strategy allows learning and change to be faster andmore effective

• Continuity of strategy avoids the cost and confusion associated withfrequent shifts in direction


Barriers to StrategyExternal• Industry conventional wisdom leads all companies to follow common practices• Customers request a full line to capture supposed purchasing efficiencies• Stock analysts and peer pressure create strong forces to emulate the practices of “successful”

companies

Internal

Faulty Management Thinking• e.g., “customer focus” is misinterpreted to mean serving all customer needs• Managers schooled in “quality is free” thinking believe that no tradeoffs should be made

Biases in Cost Systems• Inappropriate cost allocation is used to justify adding (or maintaining) new products, services, or

customer groups

Growth Pressures• The desire to grow, often driven by the apparent saturation of a company’s target market and/or the

capital markets, leads managers to broaden the company’s offering and undermine its uniqueness

Organizational Incentives• The path of least resistance is best practice improvement, which is far less organizationally

challenging than choosing and maintaining a strategy

• The greatest impediments to strategy are often self inflicted, and many are internal• Strong leadership by the CEO is almost a necessity if a strategy is to be created and implemented


Strategy and the Internet

• The Internet is an extremely important new technology

• The question is not whether to deploy Internet technology but how

• It was assumed that the Internet changes everything, rendering theold rules about companies and competition obsolete

• Many companies deployed the Internet in a way that underminedtheir industries, compromised their strategies, and eroded theircompetitive advantages

• The profitability of most Internet activities has been disappointing;many have been curtailed or shut down


• The Internet is not an industry but an enabling technology

• There are no “Internet companies,” but companies using Internettechnology to compete in particular businesses

– Dot-coms are not fundamentally different

• The Internet is creating new industries, but its principal influence is inreshaping competition in established industries to varying degrees

– more potential impact if the primary product is information vs. theprimary product is a physical good

• Even when the Internet offers significant changes to the means ofcompeting, it is not necessarily disruptive to established leaders

The Internet and CompetitionFundamentals


The Internet and Profitability

• Many Internet applications have long-run growth potential. However,rapid growth alone is not enough to produce an attractive business

• While the Internet is an improvement in technology, better technologydoes not necessarily lead to profitability. The question is who willcapture the benefits of the new technology?

• The profit potential of Internet technology depends on

– how it affects the attractiveness of industry structure

– how it affects a company’s ability to gain a competitive advantage

• These strategy fundamentals vary greatly by industry

• Notions such as “B to C” and “B to B” are meaningless for thinking aboutpotential profitability


• Most companies fell into the trap of viewing the Internet as a stand aloneopportunity, and competing solely on OE

• The focus was on maximizing revenue growth through price discounting, productline broadening, extensive promotions, channel incentives, and heavy advertising

• The aim was to create scale, gain first mover advantages, preempt the market,and accumulate customer bases

• Companies sought to capture the entire market (ideally a large one) to justify largeup-front investments, instead of establishing uniqueness and making tradeoffs toserve a well chosen sub-market

• Without a clear strategic positioning, competitive convergence resulted

• A destructive, zero sum form of competition was created

• Low price was defined as the primary customer value instead of specialization,convenience, service, or other forms of differentiation that justify a higher price.However, price advantages were not sustainable

• Most Internet-based companies competed in ways that undermined the inherentattractiveness of their industries, and created a destructive competition that is hardto reverse

Applying the Internet: The Absence of Strategy


The Internet and Industry StructureAutomobile Retailing

Threat of SubstituteProducts or Services

Rivalry AmongExisting Competitors

Bargaining Powerof Suppliers

(-) Auto producers are tempted touse their web presence tooffer direct sales

(-) New competitors from differentlocations enter the market for localcustomers

(-) New entrants have fewer dimensionsto differentiate themselves(showroom, service, …) shifting thebasis of competition towards price

(-) More market transparencyfor customers

(-) A flood of new referral networks (Auotweb,AutoVantage) and online direct dealers(Autobytel.com, AutoNation, CarsDirect.com)has entered the market

Barriers to entry

Bargaining Powerof Buyers


The Internet and Industry Structure: Typical Impacts

Threat of SubstituteProducts or Services

Rivalry AmongExisting Competitors

Bargaining Powerof Suppliers

BargainingPower ofChannels

BargainingPower ofChannels

BargainingPower ofBuyers

BargainingPower ofBuyers

(+) By making the overall industry more efficient theInternet can expand the size of the market

(-) The proliferation of Internet approaches createsnew substitution threats

(+/-) Raises bargaining power oversuppliers, though it can also givesuppliers access to morecustomers

(-) Provides a channel for suppliersto reach end users, reducing theleverage of interveningcompanies

(-) Gravitates procurement tostandardized products

(-) Offerings are difficult to keepproprietary

(-) Migrates competition to price

(-) Widens the geographic market

(-) Lowers variable cost vs. fixed cost,increasing pressures for pricediscounting

(-) Shiftsbargainingpower toendconsumers

(-) Reducesswitchingcosts

(-) Reduces barriers to entry

(-) Internet applications are difficult to keep proprietary

(+) Eliminatespowerfulchannels orimprovesbargainingpower overtraditionalchannels

Barriers to entry


The Internet and the Value Chain

• The Internet allows OE improvements through re-configuring discrete activitiesthroughout the value chain in virtually every industry and company- Introducing Internet applications in one activity often requires complementary

changes elsewhere in the value chain, often involving physical assets (e.g.,logistics)

• Internet technology is particularly powerful in communicating information and inintegrating and coordinating (fit) activities within the firm and with suppliers, channels,and customers

• Every company must have an aggressive Internet implementation program

However

• While Internet applications are important, they are neither the only nor the mostimportant driver of cost and quality; scale, employee skills, technology, and investmentin physical assets also play an important role

Suppliers Channels Customers

Firm

Marketing& Sales

(e.g. SalesForce,

Promotion,

Advertising,

ProposalWriting,

Web site)

InboundLogistics

(e.g.IncomingMaterialStorage,

DataCollection,

Service)

Operations

(e.g.Assembly,Componen

tFabrication

, BranchOperations

)

OutboundLogistics

(e.g. OrderProcessing,Warehousin

g, ReportPreparation)

After-SalesService

(e.g.Installation,CustomerSupport,

ComplaintResolution,

Repair)

Firm Infrastructure(e.g. Financing, Planning, Investor Relations)

Procurement(e.g. Components, Machinery, Advertising, Services)

Technology Development(e.g. Product Design, Testing, Process Design, Material Research, Market Research)

Human Resource Management(e.g. Recruiting, Training, Compensation System)


Selected Applications of the Internet in the Value Chain

Marketing& Sales

• On-line sales channel

• Real-time accessto customer information, product catalogs

• On-line productconfiguration

InboundLogistics

• Real-timeintegrated scheduling, ship-ping, warehousemanagement andplanning, and advanced planningand scheduling

• Dissemination ofreal-time inboundand in-progressInventory data

Operations

• Integrated informationexchange, scheduling,and decision making inin-house plants,contract assemblers,and componentsuppliers

• Real-time available-to-promise and capable-to-promise informationavailable to the salesforce and channels

OutboundLogistics

• Real-time transactionof orders

• Automated customer-specificagreements

• Customer and channel access todelivery status

After-SalesService

• On-line support ofcustomer servicerepresentatives

• Customer self-service via Websites

• Real-time field serviceaccess to customerdata

Firm Infrastructure• Web-based, distributed financial and ERP systems• On-line investor relations (e.g., information dissemination, broadcast, conference calls)

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”

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

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


Value chain / value system integration

Cross-activity integration

Activity automation / enhancement

Transaction processing

The Evolution of Information Technology in the Value Chain

Past

Future Value system optimization


Information Technology and the Value ChainOperational Effectiveness and Positioning

ActivityTailoring

• The previous generation of IT drove activity standardization and competitive convergence

• The Internet improves operational effectiveness while potentially reinforcing strategicdifferences

Customizable /Web-Based

Lower HigherOperational Effectiveness

Unique

Standard Packaged /Client Server

Custom Software/ Mainframe


Information Technology and the Value ChainTailoring and Fit

Customizable /Web-Based

Standard UniqueActivity Tailoring

GenericFit

Strategy-specific Fit

None

Fit(Cross-Activity

Integration)ERP

Most Packaged /Client ServerApplications

• Use of the Internet enables fit in the activity system that is tailored to strategy

• The Internet can be a powerful strategy tool if it is used to better tailor and integrate activities arounda unique positioning

• However, few companies are using the Internet in this way


Strategy and the InternetCore Principles

• Operational effectiveness advantages due to the Internet will usuallybe fleeting

• The Internet itself will rarely be a long term source of competitiveadvantage. It will become neutralized

• “Traditional” sources of competitive advantage will re-emerge asInternet penetration in companies rises, buyers get more sophisticated,and e-commerce becomes more established

- proprietary content

- unique products

- unique activities or parts of activities distinct from the Internet (e.g.,logistical systems)

- product knowledge and personal relationships

• The real potential of the Internet for profitability is as a strategyenabler

• The Internet can contribute to competitive advantage if Internetapplications are tailored to a company’s unique strategy

• The Internet can open up new strategic positionings


• The Internet is often complementary to existing ways of competing

• Strategies that integrate the Internet and traditional advantages / waysof competing should prevail in many industries

• Internet technology will allow new ways of combining virtual andphysical activities and creating new dimensions of value

• Integrated strategies, in which Internet applications become integralto the entire activity system, reinforce a company’s distinctivenessand are far more difficult to imitate than stand alone applications

• Given the importance of integration with traditional ways of competing,separating Internet-based operations from the rest of the companyoften undermines the potential for competitive advantage

Strategy and the InternetCore Principles (cont.)


Strategic Imperatives for Dot-Coms

• Compete in industries and applications that will support a favorable industrystructure

• Create benefits that customers are willing to pay for

- E.g., AOL has continued to charge for its services despite the existence ofcompetitors with free offers

• Widen value chains to encompass non-Internet activities and the developmentof distinctive assets

- E.g., many on-line retailers have already started to distribute paper catalogsin addition to posting their offering on the Internet

• However, do not copy established companies

- Create strategies involving new, hybrid value chains

- Alternatively, seek out trade-offs by concentrating on segments whereInternet-only models offer real advantages and trade-offs with othermethods


Recent Rationalizations of Internet True Believers

• The Internet creates large consumer benefits that traditional strategicframeworks fail to capture

– Society gains only if the value of new offerings to consumers leads to revenuesthat outweigh the costs of providing them

– Strategy frameworks are centrally concerned with the balance between revenueand cost

– The problems with the Internet stem from a failure to create applications thatwere economically viable. Such applications will emerge in the future, but will bedeveloped based on a fundamentally different mindset

• The Internet is driving rapid change. Strategy will be a distraction, with rapidexecution the real source of success

– With no strategy, a company competes on operational effectiveness which isalmost always self-defeating. This includes deployment on the Internet

– There is no inconsistency between having a strategy and continuousimprovement. All companies must incorporate the Internet into their value chains

– Strategy is even more critical in times of change, because it helps companies toset priorities and understand how to deploy new technologies. Indeed,strategy can allow companies to change faster and more effectively. Strategy willguide where to deploy the Internet, and how.


Recent Rationalizations of Internet True Believers(continued)

• The Internet is a disruptive technology rendering past strategiesobsolete. This will become evident as the Internet enters its next stage– The Internet is not a disruptive technology in most industries. It is usually

complementary to existing ways of competing, and a powerful tool forestablished as well as new companies

– Improvements in performance due to new technologies like the Internet donot necessarily imply a fundamental change in the way of competing

• The Internet will create networked competition which supplants thevertically-integrated firm– The Internet also lowers the cost of interaction among units within a

company. The overall effect of the Internet on the appropriate level ofvertical integration is ambiguous

– Outsourcing has major costs in terms of competitive differentiation andshifting bargaining power to suppliers which the networked model ignores

– Strategy concepts are independent of the level of vertical integration


Strategic Imperatives for Established Companies• Deploy the Internet; but deploy it strategically

• Use the Internet throughout the value chain to reinforce traditional competitiveadvantages and complement existing ways of competing

• Harness the power of the Internet to enable collaboration across the value chain

– e.g. collaborative design; customer-led design / configuration

• Never deploy out-of-the box solutions in important activities, but customizeapplications to strategy

Example: Edward Jones

• Brokerage firm concentrating on providing individualized advice to conservative investors likeretirees and small-business owners

• Embraced the Internet for internal management functions, recruiting, and for providingaccount statements and other information to customers

• Plans not to offer on-line trading as its competitors because self-directed on-line trading isinconsistent with Edward Jones value proposition to customers

• The company is thriving and continues to outperform rivals with me-too Internet deployments


Competition in the Post-Internet Economy

• The “new” economy involves “new” technology but does not operate by different rules

• The “old” economy and the “new” economy will merge

Old Economy New Economy

Post-Internet Economy


Strategy

• Appropriate goals

• Unique value proposition

• Tailored activities

• Activities fit together in an

integrated system

• Clear tradeoffs

• Continuity of position but

consistent improvement

What Is a Strategy? What is Not a Strategy?

• Best practice improvement

• A vision

• Learning

• Agility

• Flexibility

• Innovation

• Restructuring

• Mergers / Consolidation

• Alliances / Partnering

• The Internet


Role of Leaders

• The general manager as strategist:

- Clearly distinguish operational effectiveness from strategy

- Define and communicate the company’s unique position

- Help employees translate the strategy into their particular areas ofresponsibility

- Guide employees in making tradeoffs that arise in their individualactivities and in day-to-day decisions

- Decide which industry changes and customer needs to beresponded to, and how to tailor them to the strategy

- Avoid organizational distractions

• Strategy requires constant discipline and clear communication

Documents

Strategy and the Internet: The New Learningosservatori.sdabocconi.it/bfa/file/porter.pdf · Determinants of Relative Performance Types of Competitive Advantage ... Michael E. Porter