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Internet impact on industry competitive advantage

 

While each industry will evolve in unique ways, an examination of the forces influencing industry structure indicates that the deployment of Internet technology will likely continue to put pressure on the profitability of many industries. Consider the intensity of competition, for example. Many dot-coms are going out of business, which would seem to indicate that consolidation will take place and rivalry will be reduced. But while some consolidation among new players is inevitable, many established companies are now more familiar with Internet technology and are rapidly deploying on-line applications. With a combination of new and old companies and generally lower entry barriers, most industries will likely end up with a net increase in the number of competitors and fiercer rivalry than before the advent of the Internet.
The power of customers will also tend to rise. As buyers’ initial curiosity with the Web wanes and subsidies end, companies offering products or services on-line will be forced to demonstrate that they provide real benefits. Already, customers appear to be losing interest in services like Priceline.com’s reverse auctions because the savings they provide are often outweighed by the hassles involved. As customers become more familiar with the technology their loyalty to their initial suppliers will also decline; they will realize that the cost of switching is low.
A similar shift will affect advertising-based strategies. Even now, advertisers are becoming more discriminating, and the rate of growth of Web advertising is slowing. Advertisers can be expected to continue to exercise their bargaining power to push down rates significantly, aided and abetted by new brokers of Internet advertising.
Not all the news is bad. Some technological advances will provide opportunities to enhance profitability. Improvements in streaming video and greater availability of low-cost bandwidth, for example, will make it easier for customer service representatives, or other company personnel, to speak directly to customers through their computers. Internet sellers will be able to better differentiate themselves and shift buyers’ focus away from price. And services such as automatic bill paying by banks may modestly boost switching costs. In general, however, new Internet technologies will continue to erode profitability by shifting power to customers.
To understand the importance of thinking through the longer-term structural consequences of the Internet, consider the business of digital marketplaces.
Such marketplaces automate corporate procurement by linking many buyers and suppliers electronically. The benefits to buyers include low transaction costs, easier access to price and product information, convenient purchase of associated services, and, sometimes, the ability to pool volume. The benefits to suppliers include lower selling costs, lower transaction costs, access to wider markets, and the avoidance of powerful channels.

From an industry structure standpoint, the attractiveness of digital marketplaces varies depending on the products involved. The most important determinant of a marketplace’s profit potential is the intrinsic power of the buyers and sellers in the particular product area. If either side is concentrated or possesses differentiated products, it will gain bargaining power over the marketplace and capture most of the value generated. If buyers and sellers are fragmented, however, their bargaining power will be weak, and the marketplace will have a much better chance of being profitable.

Another important determinant of industry structure is the threat of substitution. If it is relatively easy for buyers and sellers to transact business directly with one another, or to set up their own dedicated markets, independent marketplaces will be unlikely to sustain high levels of profit.

Finally, the ability to create barriers to entry is critical. Today, with dozens of marketplaces competing in some industries and with buyers and sellers dividing their purchases or operating their own markets to prevent any one marketplace from gaining power, it is clear that modest entry barriers are a real challenge to profitability.

Competition among digital marketplaces is in transition, and industry structure is evolving. Much of the economic value created by marketplaces derives from the standards they establish, both in the underlying technology platform and in the protocols for connecting and exchanging information. But once these standards are put in place, the added value of the marketplace may be limited. Anything buyers or suppliers provide to a marketplace, such as information on order specifications or inventory availability, can be readily provided on their own proprietary sites. Suppliers and customers can begin to deal directly on-line without the need for an intermediary. And new technologies will undoubtedly make it easier for parties to search for and exchange goods and information with one another.

In some product areas, marketplaces should enjoy ongoing advantages and attractive profitability. In fragmented industries such as real estate and furniture, for example, they could prosper. And new kinds of value-added services may arise that only an independent marketplace could provide. But in many product areas, marketplaces may be superseded by direct dealing or by the unbundling of purchasing, information, financing, and logistical services; in other areas, they may be taken over by participants or industry associations as cost centers. In such cases, marketplaces will provide a valuable ‘public good’ to participants but will not themselves be likely to reap any enduring benefits. Over the long haul, moreover, we may well see many buyers back away from open marketplaces. They may once again focus on building close, proprietary relationships with fewer suppliers, using Internet technologies to gain efficiency improvements in various aspects of those relationships.

The Internet  advantage
If average profitability is under pressure in many industries influenced by the Internet, it becomes all the more important for individual companies to set themselves apart from the pack – to be more profitable than the average performer. The only way to do so is by achieving a sustainable competitive advantage – by operating at a lower cost, by commanding a premium price, or by doing both. Cost and price advantages can be achieved in two ways. One is operational effectiveness – doing the same things your competitors do but doing them better.

Operational effectiveness advantages can take myriad forms, including better technologies, superior inputs, better-trained people, or a more effective management structure. The other way to achieve advantage is strategic positioning – doing things differently from competitors, in a way that delivers a unique type of value to customers. This can mean offering a different set of features, a different array of services, or different logistical arrangements. The Internet affects operational effectiveness and strategic positioning in very different ways. It makes it harder for companies to sustain operational advantages, but it opens new opportunities for achieving or strengthening a distinctive strategic positioning.

Operational effectiveness

The Internet is arguably the most powerful tool available today for enhancing operational effectiveness. By easing and speeding the exchange of real-time information, it enables improvements throughout the entire value chain, across almost every company and industry. And because it is an open platform with common standards, companies can often tap into its benefits with much less investment than was required to capitalize on past generations of information technology.

But simply improving operational effectiveness does not provide a competitive advantage. Companies only gain advantages if they are able to achieve and sustain higher levels of operational effectiveness than competitors. That is an exceedingly difficult proposition even in the best of circumstances. Once a company establishes a new best practice, its rivals tend to copy it quickly. Best practice competition eventually leads to competitive convergence, with many companies doing the same things in the same ways. Customers end up making decisions based on price, undermining industry profitability.

The nature of Internet applications makes it more difficult to sustain operational advantages than ever. In previous generations of information technology, application development was often complex, arduous, time consuming, and hugely expensive. These traits made it harder to gain an IT advantage, but they also made it difficult for competitors to imitate information systems. The openness of the Internet, combined with advances in software architecture, development tools, and modularity, makes it much easier for companies to design and implement applications. The drugstore chain CVS, for example, was able to roll out a complex Internet-based procurement application in just 60 days. As the fixed costs of developing systems decline, the barriers to imitation fall as well.

Today, nearly every company is developing similar types of Internet applications, often drawing on generic packages offered by third-party developers. The resulting improvements in operational effectiveness will be broadly shared, as companies converge on the same applications with the same benefits. Very rarely will individual companies be able to gain durable advantages from the deployment of ‘best-of-breed’ applications.

Strategic positioning

As it becomes harder to sustain operational advantages, strategic positioning becomes all the more important. If a company cannot be more operationally effective than its rivals, the only way to generate higher levels of economic value is to gain a cost advantage or price premium by competing in a distinctive way. Ironically, companies today define competition involving the

Internet almost entirely in terms of operational effectiveness. Believing that no sustainable advantages exist, they seek speed and agility, hoping to stay one step ahead of the competition. Of course, such an approach to competition becomes a self-fulfilling prophecy. Without a distinctive strategic direction, speed and flexibility lead nowhere. Either no unique competitive advantages are created, or improvements are generic and cannot be sustained.

Having a strategy is a matter of discipline. It requires a strong focus on profitability rather than just growth, an ability to define a unique value proposition, and a willingness to make tough trade-offs in choosing what not to do. A company must stay the course, even during times of upheaval, while constantly improving and extending its distinctive positioning. Strategy goes far beyond the pursuit of best practices. It involves the configuration of a tailored value chain – the series of activities required to produce and deliver a product or service – that enables a company to offer unique value. To be defensible, moreover, the value chain must be highly integrated. When a company’s activities fit together as a self-reinforcing system, any competitor wishing to imitate a strategy must replicate the whole system rather than copy just one or two discrete product features or ways of performing particular activities.

Many of the pioneers of Internet business, both dot-coms and established companies, have competed in ways that violate nearly every precept of good strategy. Rather than focus on profits, they have sought to maximize revenue and market share at all costs, pursuing customers indiscriminately through discounting, giveaways, promotions, channel incentives, and heavy advertising. Rather than concentrate on delivering real value that earns an attractive price from customers, they have pursued indirect revenues from sources such as advertising and click-through fees from Internet commerce partners. Rather than make trade-offs, they have rushed to offer every conceivable product, service, or type of information. Rather than tailor the value chain in a unique way, they have aped 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. While it is true that some companies have avoided these mistakes, they are exceptions to the rule.

By ignoring strategy, many companies have undermined the structure of their industries, hastened competitive convergence, and reduced the likelihood that they or anyone else will gain a competitive advantage. A destructive, zero-sum form of competition has been set in motion that confuses the acquisition of customers with the building of profitability. Worse yet, price has been defined as the primary if not the sole competitive variable.

Instead of emphasizing the Internet’s ability to support convenience, service, specialization, customization, and other forms of value that justify attractive prices, companies have turned competition into a race to the bottom. Once competition is defined this way, it is very difficult to turn back. (See the sidebar ‘Words for the unwise: the Internet’s destructive lexicon.’)
Even well-established, well-run companies have been thrown off track by the Internet. Forgetting what they stand for or what makes them unique, they have rushed to implement hot Internet applications and copy the offerings of dot-coms. Industry leaders have compromised their existing competitive advantages by entering market segments to which they bring little that is distinctive. Merrill Lynch’s move to imitate the low-cost on-line offerings of its trading rivals, for example, risks undermining its most precious advantage – its skilled brokers. And many established companies, reacting to misguided investor enthusiasm, have hastily cobbled together Internet units in a mostly futile effort to boost their value in the stock market.
It did not have to be this way – and it does not have to be in the future.
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. Indeed, IT worked against strategy in the past.

Packaged software applications were hard to customize, and companies were often forced to change the way they conducted activities in order to conform to the ‘best practices’ embedded in the software. It was also extremely difficult to connect discrete applications to one another. Enterprise resource planning (ERP) systems linked activities, but again companies were forced to adapt their ways of doing things to the software. As a result, IT has been a force for standardizing activities and speeding competitive convergence.

Internet architecture, together with other improvements in software architecture and development tools, has turned IT into a far more powerful tool for strategy. It is much easier to customize packaged Internet applications to a company’s unique strategic positioning. By providing a common IT delivery platform across the value chain, Internet architecture and standards also make it possible to build truly integrated and customized systems that reinforce the fit among activities. (See the sidebar ‘The Internet and the value chain.’)

To gain these advantages, however, 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. Although it remains more difficult to customize packaged applications, the very difficulty of the task contributes to the sustainability of the resulting competitive advantage.

The Internet, then, is often not disruptive to existing industries or established companies. It rarely nullifies the most important sources of competitive advantage in an industry; in many cases it actually makes those sources even more important. As all companies come to embrace Internet technology, moreover, the Internet itself will be neutralized as a source of advantage.

Basic Internet applications will become table stakes – companies will not be able to survive without them, but they will not gain any advantage from them.
The more robust competitive advantages will arise instead from traditional strengths such as unique products, proprietary content, distinctive physical activities, superior product knowledge, and strong personal service and relationships. Internet technology may be able to fortify those advantages, by tying a company’s activities together in a more distinctive system, but it is unlikely to supplant them.

Ultimately, strategies that integrate the Internet and traditional competitive advantages and ways of competing should win in many industries. On the demand side, most buyers will value a combination of on-line services, personal services, and physical locations over stand-alone Web distribution.
They will want a choice of channels, delivery options, and ways of dealing with companies. On the supply side, production and procurement will be more effective if they involve a combination of Internet and traditional methods, tailored to strategy. For example, customized, engineered inputs will be bought directly, facilitated by Internet tools. Commodity items may be purchased via digital markets, but purchasing experts, supplier sales forces, and stocking locations will often also provide useful, value-added services.

 

The value of integrating traditional and Internet methods creates potential advantages for established companies. It will be easier for them to adopt and integrate traditional ones. It is not enough, however, just to graft the Internet onto historical ways of competing in simplistic ‘clicks-and-mortar’ configurations. Established companies will be most successful when they deploy
Internet technology to reconfigure traditional activities or when they find new combinations of Internet and traditional approaches. Dot-coms, first and foremost, must pursue their own distinctive strategies, rather than emulate one another or the positioning of established companies.
They will have to break away from competing solely on price and instead focus on product selection, product design, service, image, and other areas in which they can differentiate themselves. Dot-coms can also drive the combination of
Internet and traditional methods. Some will succeed by creating their own distinctive ways of doing so. Others will succeed by concentrating on market segments that exhibit real trade-offs between Internet and traditional methods – either those in which a pure Internet approach best meets the needs of a particular set of customers or those in which a particular product or service can be best delivered without the need for physical assets. (See the sidebar ‘Strategic Imperatives for Dot-Coms and Established Companies.’)
These principles are already manifesting themselves in many industries, as traditional leaders reassert their strengths and dot-coms adopt more focused

 

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