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A R T I C L E

Strategy and the Internet

by Michael E. Porter

Included with this full-text Harvard Business Review article:

The Idea in Brief—the core idea

The Idea in Practice—putting the idea to work

1 Article Summary

2 Strategy and the Internet

A list of related materials, with annotations to guide further

exploration of the article’s ideas and applications

20 Further Reading

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The Idea in Brief The Idea in Practice

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Does the Internet render established rules about strategy obsolete? To the con-

ary, it makes them more vital than ever.hy? The Internet weakens industries’ prof-

ability, as rivals compete on price alone. nd it no longer provides proprietary advan-ges, as virtually all companies now use the eb.

he Internet is no more than a tool—albeit a owerful one—that can support or damage our firm’s strategic positioning. The key to sing it most effectively? Integrate Internet itiatives into your company’s overall strat-

gy and operations so that they 1) comple-ent, rather than cannibalize, your estab-

shed competitive approaches and 2) create ystemic advantages that your competitors an’t copy.

tegrating Internet initiatives enhances your ompany’s ability to develop unique prod-cts, proprietary content, distinctive pro-esses, and strong personal service—all the ings that create true value, and that have

lways defined competitive advantage.

THE INTERNET’S INFLUENCE

The Internet powerfully influences industry structure and sustainable competitive advan-tage.

Industry structure derives from the basic forces of competition: competitor rivalry; entry barriers for new competitors; the threat of substitute offerings; and the bargaining power of suppliers, channels, and buyers. How does the Internet affect these forces?

• It’s an open system whose technological advances level most industries’ playing fields—thus intensifying competitive rivalry and reducing entry barriers.

• It dramatically increases available informa-tion, shifting bargaining power to buyers.

Sustainable competitive advantage comes from operational effectiveness (doing what your competitors do, but better) or strategic positioning (delivering unique value to cus-tomers by doing things differently than your competitors).

Most companies define Internet competition in terms of operational effectiveness (speed, flexibility, efficiency). But because competitors can easily copy your firm’s advances in these areas, strategic positioning becomes most im-portant.

THE INTERNET AS STRATEGIC COMPLEMENT

Although the Internet makes it difficult to sus-tain operational effectiveness, it makes it eas-ier to maintain strategic positioning. How?

• It lets you create a customized, common in-formation technology platform for all your company’s activities—resulting in unique, integrated systems that reinforce the strate-gic fit among your firm’s many functions. Even better, competitors can’t easily imitate these systems.

• Rather than cannibalizing your traditional ways of competing, it can complement

them. For example, the Walgreens drug-store chain provides on-line prescription or-dering. Because 90% of customers who order over the Web prefer to pick up their prescriptions at a store, Walgreens brick-and-mortar business benefits.

• By integrating virtual and physical activities to compensate for the Internet’s perfor-mance limits (e.g., customers can’t physi-cally touch and test products), companies gain competitive advantage. For example, if you use your Web site to attract customers and draw them to flesh-and-blood sales-people who provide personalized advice and after-sales service, you reinforce con-nections—and strengthen sales.

The question isn’t whether you should use the Internet or traditional methods to compete; it’s how you can use both to your greatest strategic advantage.

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by Michael E. Porter

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harvard business review • march 2001

Many have argued that the Internet renders strategy obsolete. In reality,

the opposite is true. Because the Internet tends to weaken industry

profitability without providing proprietary operational advantages, it is

more important than ever for companies to distinguish themselves

through strategy. The winners will be those that view the Internet as a

complement to, not a cannibal of, traditional ways of competing.

The Internet is an extremely important newtechnology, and it is no surprise that it has re-ceived so much attention from entrepreneurs,executives, investors, and business observers.Caught up in the general fervor, many haveassumed that the Internet changes every-thing, rendering all the old rules about compa-nies and competition obsolete. That may be anatural reaction, but it is a dangerous one. Ithas led many companies, dot-coms and incum-bents alike, to make bad decisions—decisionsthat have eroded the attractiveness of their in-dustries and undermined their own competi-tive advantages. Some companies, for exam-ple, have used Internet technology to shift thebasis of competition away from quality, fea-tures, and service and toward price, making itharder for anyone in their industries to turn aprofit. Others have forfeited important propri-etary advantages by rushing into misguidedpartnerships and outsourcing relationships.Until recently, the negative effects of these ac-tions have been obscured by distorted signalsfrom the marketplace. Now, however, the

consequences are becoming evident.The time has come to take a clearer view of

the Internet. We need to move away from therhetoric about “Internet industries,” “e-busi-ness strategies,” and a “new economy” and seethe Internet for what it is: an enabling technol-ogy—a powerful set of tools that can be used,wisely or unwisely, in almost any industry andas part of almost any strategy. We need to askfundamental questions: Who will capture theeconomic benefits that the Internet creates?Will all the value end up going to customers,or will companies be able to reap a share of it?What will be the Internet’s impact on industrystructure? Will it expand or shrink the pool ofprofits? And what will be its impact on strat-egy? Will the Internet bolster or erode the abil-ity of companies to gain sustainable advan-tages over their competitors?

In addressing these questions, much of whatwe find is unsettling. I believe that the experi-ences companies have had with the Internetthus far must be largely discounted and thatmany of the lessons learned must be forgotten.

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Michael E. Porter

is the Bishop Will-iam Lawrence University Professor atHarvard University; he is based at Har-vard Business School in Boston. He haswritten many articles for HBR; the mostrecent, “Philanthropy’s New Agenda:Creating Value,” coauthored by Mark R.Kramer, appeared in the November–December 1999 issue. His book

CanJapan Compete?

, coauthored by Hiro-taka Takeuchi and Mariko Sakakibara,was recently published in the UnitedStates by Perseus/Basic Books.

When seen with fresh eyes, it becomes clearthat the Internet is not necessarily a blessing. Ittends to alter industry structures in ways thatdampen overall profitability, and it has a level-ing effect on business practices, reducing theability of any company to establish an opera-tional advantage that can be sustained.

The key question is not whether to deployInternet technology—companies have nochoice if they want to stay competitive—buthow to deploy it. Here, there is reason for opti-mism. Internet technology provides better op-portunities for companies to establish distinc-tive strategic positionings than did previousgenerations of information technology. Gain-ing such a competitive advantage does not re-quire a radically new approach to business. Itrequires building on the proven principles ofeffective strategy. The Internet per se willrarely be a competitive advantage. Many ofthe companies that succeed will be ones thatuse the Internet as a complement to tradi-tional ways of competing, not those that settheir Internet initiatives apart from their es-tablished operations. That is particularly goodnews for established companies, which areoften in the best position to meld Internet andtraditional approaches in ways that buttressexisting advantages. But dot-coms can also bewinners—if they understand the trade-offs be-tween Internet and traditional approaches andcan fashion truly distinctive strategies. Farfrom making strategy less important, as somehave argued, the Internet actually makes strat-egy more essential than ever.

Distorted Market SignalsCompanies that have deployed Internet tech-nology have been confused by distorted mar-ket signals, often of their own creation. It isunderstandable, when confronted with a newbusiness phenomenon, to look to marketplaceoutcomes for guidance. But in the early stagesof the rollout of any important new technol-ogy, market signals can be unreliable. Newtechnologies trigger rampant experimenta-tion, by both companies and customers, andthe experimentation is often economically un-sustainable. As a result, market behavior is dis-torted and must be interpreted with caution.

That is certainly the case with the Internet.Consider the revenue side of the profit equa-tion in industries in which Internet technologyis widely used. Sales figures have been unreli-

able for three reasons. First, many companieshave subsidized the purchase of their productsand services in hopes of staking out a positionon the Internet and attracting a base of cus-tomers. (Governments have also subsidizedon-line shopping by exempting it from salestaxes.) Buyers have been able to purchasegoods at heavy discounts, or even obtain themfor free, rather than pay prices that reflect truecosts. When prices are artificially low, unit de-mand becomes artificially high. Second, manybuyers have been drawn to the Internet out ofcuriosity; they have been willing to conducttransactions on-line even when the benefitshave been uncertain or limited. If Ama-zon.com offers an equal or lower price than aconventional bookstore and free or subsidizedshipping, why not try it as an experiment?Sooner or later, though, some customers canbe expected to return to more traditionalmodes of commerce, especially if subsidiesend, making any assessment of customer loy-alty based on conditions so far suspect. Finally,some “revenues” from on-line commerce havebeen received in the form of stock rather thancash. Much of the estimated $450 million inrevenues that Amazon has recognized from itscorporate partners, for example, has come asstock. The sustainability of such revenue isquestionable, and its true value hinges on fluc-tuations in stock prices.

If revenue is an elusive concept on the In-ternet, cost is equally fuzzy. Many companiesdoing business on-line have enjoyed subsidizedinputs. Their suppliers, eager to affiliate them-selves with and learn from dot-com leaders,have provided products, services, and contentat heavily discounted prices. Many contentproviders, for example, rushed to provide theirinformation to Yahoo! for next to nothing inhopes of establishing a beachhead on one ofthe Internet’s most visited sites. Some provid-ers have even paid popular portals to distrib-ute their content. Further masking true costs,many suppliers—not to mention employees—have agreed to accept equity, warrants, orstock options from Internet-related companiesand ventures in payment for their services orproducts. Payment in equity does not appearon the income statement, but it is a real cost toshareholders. Such supplier practices have arti-ficially depressed the costs of doing businesson the Internet, making it appear more attrac-tive than it really is. Finally, costs have been

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Internet technology

provides better

opportunities for

companies to establish

distinctive strategic

positionings than did

previous generations of

information technology.

distorted by the systematic understatement ofthe need for capital. Company after companytouted the low asset intensity of doing businesson-line, only to find that inventory, ware-houses, and other investments were necessaryto provide value to customers.

Signals from the stock market have beeneven more unreliable. Responding to investorenthusiasm over the Internet’s explosivegrowth, stock valuations became decoupledfrom business fundamentals. They no longerprovided an accurate guide as to whether realeconomic value was being created. Any com-pany that has made competitive decisionsbased on influencing near-term share price orresponding to investor sentiments has put it-self at risk.

Distorted revenues, costs, and share priceshave been matched by the unreliability of thefinancial metrics that companies haveadopted. The executives of companies con-ducting business over the Internet have, con-veniently, downplayed traditional measures ofprofitability and economic value. Instead, theyhave emphasized expansive definitions of rev-enue, numbers of customers, or, even moresuspect, measures that might someday corre-late with revenue, such as numbers of uniqueusers (“reach”), numbers of site visitors, orclick-through rates. Creative accounting ap-proaches have also multiplied. Indeed, the In-ternet has given rise to an array of new perfor-mance metrics that have only a looserelationship to economic value, such as proforma measures of income that remove “non-recurring” costs like acquisitions. The dubiousconnection between reported metrics and ac-tual profitability has served only to amplify theconfusing signals about what has been work-ing in the marketplace. The fact that thosemetrics have been taken seriously by the stockmarket has muddied the waters even further.For all these reasons, the true financial perfor-mance of many Internet-related businesses iseven worse than has been stated.

One might argue that the simple prolifera-tion of dot-coms is a sign of the economicvalue of the Internet. Such a conclusion is pre-mature at best. Dot-coms multiplied so rapidlyfor one major reason: they were able to raisecapital without having to demonstrate viabil-ity. Rather than signaling a healthy businessenvironment, the sheer number of dot-coms inmany industries often revealed nothing more

than the existence of low barriers to entry, al-ways a danger sign.

A Return to FundamentalsIt is hard to come to any firm understanding ofthe impact of the Internet on business by look-ing at the results to date. But two broad con-clusions can be drawn. First, many businessesactive on the Internet are artificial businessescompeting by artificial means and propped upby capital that until recently had been readilyavailable. Second, in periods of transition suchas the one we have been going through, itoften appears as if there are new rules of com-petition. But as market forces play out, as theyare now, the old rules regain their currency.The creation of true economic value onceagain becomes the final arbiter of businesssuccess.

Economic value for a company is nothingmore than the gap between price and cost, andit is reliably measured only by sustained profit-ability. To generate revenues, reduce expenses,or simply do something useful by deploying In-ternet technology is not sufficient evidencethat value has been created. Nor is a com-pany’s current stock price necessarily an indi-cator of economic value. Shareholder value isa reliable measure of economic value onlyover the long run.

In thinking about economic value, it is use-ful to draw a distinction between the uses ofthe Internet (such as operating digital market-places, selling toys, or trading securities) andInternet technologies (such as site-customiza-tion tools or real-time communications ser-vices), which can be deployed across manyuses. Many have pointed to the success of tech-nology providers as evidence of the Internet’seconomic value. But this thinking is faulty. It isthe uses of the Internet that ultimately createeconomic value. Technology providers canprosper for a time irrespective of whether theuses of the Internet are profitable. In periodsof heavy experimentation, even sellers offlawed technologies can thrive. But unless theuses generate sustainable revenues or savingsin excess of their cost of deployment, the op-portunity for technology providers will shrivelas companies realize that further investment iseconomically unsound.

So how can the Internet be used to createeconomic value? To find the answer, we needto look beyond the immediate market signals

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to the two fundamental factors that determineprofitability:

• industry structure, which determines theprofitability of the average competitor; and

• sustainable competitive advantage, whichallows a company to outperform the averagecompetitor.

These two underlying drivers of profitabil-ity are universal; they transcend any technol-ogy or type of business. At the same time, theyvary widely by industry and company. Thebroad, supra-industry classifications so com-mon in Internet parlance, such as business-to-consumer (or “B2C”) and business-to-business(or “B2B”) prove meaningless with respect toprofitability. Potential profitability can be un-derstood only by looking at individual indus-tries and individual companies.

The Internet and Industry StructureThe Internet has created some new industries,such as on-line auctions and digital market-places. However, its greatest impact has beento enable the reconfiguration of existing in-dustries that had been constrained by highcosts for communicating, gathering informa-tion, or accomplishing transactions. Distancelearning, for example, has existed for decades,with about one million students enrolling incorrespondence courses every year. The Inter-net has the potential to greatly expand dis-tance learning, but it did not create the indus-try. Similarly, the Internet provides anefficient means to order products, but catalogretailers with toll-free numbers and auto-mated fulfillment centers have been aroundfor decades. The Internet only changes thefront end of the process.

Whether an industry is new or old, its struc-tural attractiveness is determined by five un-derlying forces of competition: the intensity ofrivalry among existing competitors, the barri-ers to entry for new competitors, the threat ofsubstitute products or services, the bargainingpower of suppliers, and the bargaining powerof buyers. In combination, these forces deter-mine how the economic value created by anyproduct, service, technology, or way of com-peting is divided between, on the one hand,companies in an industry and, on the other,customers, suppliers, distributors, substitutes,and potential new entrants. Although somehave argued that today’s rapid pace of techno-logical change makes industry analysis less

valuable, the opposite is true. Analyzing theforces illuminates an industry’s fundamentalattractiveness, exposes the underlying driversof average industry profitability, and providesinsight into how profitability will evolve in thefuture. The five competitive forces still deter-mine profitability even if suppliers, channels,substitutes, or competitors change.

Because the strength of each of the fiveforces varies considerably from industry to in-dustry, it would be a mistake to draw generalconclusions about the impact of the Interneton long-term industry profitability; each indus-try is affected in different ways. Nevertheless,an examination of a wide range of industries inwhich the Internet is playing a role revealssome clear trends, as summarized in the ex-hibit “How the Internet Influences IndustryStructure.” Some of the trends are positive.For example, the Internet tends to dampen thebargaining power of channels by providingcompanies with new, more direct avenues tocustomers. The Internet can also boost an in-dustry’s efficiency in various ways, expandingthe overall size of the market by improving itsposition relative to traditional substitutes.

But most of the trends are negative. Inter-net technology provides buyers with easier ac-cess to information about products and suppli-ers, thus bolstering buyer bargaining power.The Internet mitigates the need for suchthings as an established sales force or access toexisting channels, reducing barriers to entry.By enabling new approaches to meeting needsand performing functions, it creates new sub-stitutes. Because it is an open system, compa-nies have more difficulty maintaining propri-etary offerings, thus intensifying the rivalryamong competitors. The use of the Internetalso tends to expand the geographic market,bringing many more companies into competi-tion with one another. And Internet technolo-gies tend to reduce variable costs and tilt coststructures toward fixed cost, creating signifi-cantly greater pressure for companies to en-gage in destructive price competition.

While deploying the Internet can expandthe market, then, doing so often comes at theexpense of average profitability. The great par-adox of the Internet is that its very benefits—making information widely available; reducingthe difficulty of purchasing, marketing, anddistribution; allowing buyers and sellers to findand transact business with one another more

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Bargaining power of suppliers

(+/-) Procurement using the Internet tends to raise bargaining power over suppliers, though it can also give suppliers access to more customers

(-) The Internet provides a channel for suppliers to reach end users, reducing the leverage of intervening companies

(-) Internet procurement and digitalmarkets tend to give all companieequal access to suppliers, and gravitate procurement to standardized products that reduce differentiation

(-) Reduced barriers to entry and the proliferation of competitors downstream shifts power to suppliers

Bargaining powerof suppliers

This discussion is drawn from the authoFor a fuller discussion, see M.E. Porter, C

How the Intern

easily—also make it more difficult for compa-nies to capture those benefits as profits.

We can see this dynamic at work in automo-bile retailing. The Internet allows customers togather extensive information about productseasily, from detailed specifications and repairrecords to wholesale prices for new cars andaverage values for used cars. Customers canalso choose among many more options fromwhich to buy, not just local dealers but alsovarious types of Internet referral networks(such as Autoweb and AutoVantage) and on-

line direct dealers (such as Autobytel.com, Au-toNation, and CarsDirect.com). Because theInternet reduces the importance of location, atleast for the initial sale, it widens the geo-graphic market from local to regional or na-tional. Virtually every dealer or dealer groupbecomes a potential competitor in the mar-ket. It is more difficult, moreover, for on-linedealers to differentiate themselves, as theylack potential points of distinction such asshowrooms, personal selling, and service de-partments. With more competitors selling

Threat of substitute products or services

Barriers to entry

s

(-) Reduces barriers to entry such as the need for a sales force, access to channels, and physical assets – anything that Internet technology eliminates or makes easier to do reduces barriers to entry

(-) Internet applications are difficult to keep proprietary from new entrants

(-) A flood of new entrants has come into many industries

(+) Eliminates powerful channels or improves bargaining power over traditional channels

Bargaining power of end users

(-) Shifts bargaining power to end consumers

(-) Reduces switching costs

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

(-) The proliferation of Internet approaches creates new substitution threats

(-) Reduces differences among competitors as offerings are difficult to keep proprietary

(-) Migrates competition to price

(-) Widens the geographic market, increasing the number of competitors

(-) Lowers variable cost relative to fixed cost, increasing pressures for price discounting

BuyersRivalry amongexisting competitors

Bargaining power of channels

r’s research with David Sutton.ompetitive Strategy, Free Press, 1980.

et Influences Industry Structure

page 6



largely undifferentiated products, the basis forcompetition shifts ever more toward price.Clearly, the net effect on the industry’s struc-ture is negative.

That does not mean that every industry inwhich Internet technology is being applied willbe unattractive. For a contrasting example,look at Internet auctions. Here, customers andsuppliers are fragmented and thus have littlepower. Substitutes, such as classified ads andflea markets, have less reach and are less con-venient to use. And though the barriers toentry are relatively modest, companies canbuild economies of scale, both in infrastruc-ture and, even more important, in the aggrega-tion of many buyers and sellers, that deter newcompetitors or place them at a disadvantage.Finally, rivalry in this industry has been de-fined, largely by eBay, the dominant competi-tor, in terms of providing an easy-to-use mar-ketplace in which revenue comes from listingand sales fees, while customers pay the cost ofshipping. When Amazon and other rivals en-tered the business, offering free auctions, eBaymaintained its prices and pursued other waysto attract and retain customers. As a result, thedestructive price competition characteristic ofother on-line businesses has been avoided.

EBay’s role in the auction business providesan important lesson: industry structure is notfixed but rather is shaped to a considerable de-gree by the choices made by competitors. EBayhas acted in ways that strengthen the profit-ability of its industry. In stark contrast,Buy.com, a prominent Internet retailer, actedin ways that undermined its industry, not tomention its own potential for competitive ad-vantage. Buy.com achieved $100 million insales faster than any company in history, but itdid so by defining competition solely on price.It sold products not only below full cost but ator below cost of goods sold, with the vain hopethat it would make money in other ways. Thecompany had no plan for being the low-costprovider; instead, it invested heavily in brandadvertising and eschewed potential sources ofdifferentiation by outsourcing all fulfillmentand offering the bare minimum of customerservice. It also gave up the opportunity to setitself apart from competitors by choosing notto focus on selling particular goods; it movedquickly beyond electronics, its initial category,into numerous other product categories inwhich it had no unique offering. Although the

company has been trying desperately to repo-sition itself, its early moves have proven ex-tremely difficult to reverse.

The Myth of the First Mover Given the negative implications of the Inter-net for profitability, why was there such opti-mism, even euphoria, surrounding its adop-tion? One reason is that everyone tended tofocus on what the Internet could do and howquickly its use was expanding rather than onhow it was affecting industry structure. Butthe optimism can also be traced to a wide-spread belief that the Internet would unleashforces that would enhance industry profitabil-ity. Most notable was the general assumptionthat the deployment of the Internet would in-crease switching costs and create strong net-work effects, which would provide first mov-ers with competitive advantages and robustprofitability. First movers would reinforcethese advantages by quickly establishingstrong new-economy brands. The result wouldbe an attractive industry for the victors. Thisthinking does not, however, hold up to closeexamination.

Consider switching costs. Switching costsencompass all the costs incurred by a customerin changing to a new supplier—everythingfrom hashing out a new contract to reenteringdata to learning how to use a different productor service. As switching costs go up, customers’bargaining power falls and the barriers toentry into an industry rise. While switchingcosts are nothing new, some observers arguedthat the Internet would raise them substan-tially. A buyer would grow familiar with onecompany’s user interface and would not wantto bear the cost of finding, registering with,and learning to use a competitor’s site, or, inthe case of industrial customers, integrating acompetitor’s systems with its own. Moreover,since Internet commerce allows a company toaccumulate knowledge of customers’ buyingbehavior, the company would be able to pro-vide more tailored offerings, better service,and greater purchasing convenience—all ofwhich buyers would be loath to forfeit. Whenpeople talk about the “stickiness” of Web sites,what they are often talking about is highswitching costs.

In reality, though, switching costs are likelyto be lower, not higher, on the Internet thanthey are for traditional ways of doing business,

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Another myth that has

generated unfounded

enthusiasm for the

Internet is that

partnering is a win-win

means to improve

industry economics.

including approaches using earlier generationsof information systems such as EDI. On the In-ternet, buyers can often switch suppliers withjust a few mouse clicks, and new Web technol-ogies are systematically reducing switchingcosts even further. For example, companieslike PayPal provide settlement services or In-ternet currency—so-called e-wallets—that en-able customers to shop at different sites with-out having to enter personal information andcredit card numbers. Content-consolidationtools such as OnePage allow users to avoidhaving to go back to sites over and over to re-trieve information by enabling them to buildcustomized Web pages that draw needed infor-mation dynamically from many sites. And thewidespread adoption of XML standards willfree companies from the need to reconfigureproprietary ordering systems and to createnew procurement and logistical protocolswhen changing suppliers.

What about network effects, through whichproducts or services become more valuable asmore customers use them? A number of im-portant Internet applications display networkeffects, including e-mail, instant messaging,auctions, and on-line message boards or chatrooms. Where such effects are significant, theycan create demand-side economies of scaleand raise barriers to entry. This, it has beenwidely argued, sets off a winner-take-all com-petition, leading to the eventual dominance ofone or two companies.

But it is not enough for network effects tobe present; to provide barriers to entry theyalso have to be proprietary to one company.The openness of the Internet, with its commonstandards and protocols and its ease of naviga-tion, makes it difficult for a single company tocapture the benefits of a network effect.(America Online, which has managed to main-tain borders around its on-line community, isan exception, not the rule.) And even if a com-pany is lucky enough to control a network ef-fect, the effect often reaches a point of dimin-ishing returns once there is a critical mass ofcustomers. Moreover, network effects are sub-ject to a self-limiting mechanism. A particularproduct or service first attracts the customerswhose needs it best meets. As penetrationgrows, however, it will tend to become less ef-fective in meeting the needs of the remainingcustomers in the market, providing an openingfor competitors with different offerings. Fi-

nally, creating a network effect requires a largeinvestment that may offset future benefits.The network effect is, in many respects, akinto the experience curve, which was also sup-posed to lead to market-share dominance—through cost advantages, in that case. The ex-perience curve was an oversimplification, andthe single-minded pursuit of experience curveadvantages proved disastrous in many indus-tries.

Internet brands have also proven difficult tobuild, perhaps because the lack of physicalpresence and direct human contact makes vir-tual businesses less tangible to customers thantraditional businesses. Despite huge outlays onadvertising, product discounts, and purchasingincentives, most dot-com brands have not ap-proached the power of established brands,achieving only a modest impact on loyalty andbarriers to entry.

Another myth that has generated un-founded enthusiasm for the Internet is thatpartnering is a win-win means to improve in-dustry economics. While partnering is a well-established strategy, the use of Internet tech-nology has made it much more widespread.Partnering takes two forms. The first involvescomplements: products that are used in tan-dem with another industry’s product. Com-puter software, for example, is a complementto computer hardware. In Internet commerce,complements have proliferated as companieshave sought to offer broader arrays of prod-ucts, services, and information. Partnering toassemble complements, often with companieswho are also competitors, has been seen as away to speed industry growth and move awayfrom narrow-minded, destructive competition.

But this approach reveals an incomplete un-derstanding of the role of complements incompetition. Complements are frequently im-portant to an industry’s growth—spreadsheetapplications, for example, accelerated the ex-pansion of the personal computer industry—but they have no direct relationship to indus-try profitability. While a close substitute re-duces potential profitability, for example, aclose complement can exert either a positiveor a negative influence. Complements affectindustry profitability indirectly through theirinfluence on the five competitive forces. If acomplement raises switching costs for thecombined product offering, it can raise profit-ability. But if a complement works to standard-

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ize the industry’s product offering, as Mi-crosoft’s operating system has done inpersonal computers, it will increase rivalry anddepress profitability.

With the Internet, widespread partneringwith producers of complements is just as likelyto exacerbate an industry’s structural prob-lems as mitigate them. As partnerships prolif-erate, companies tend to become more alike,which heats up rivalry. Instead of focusing ontheir own strategic goals, moreover, compa-nies are forced to balance the many potentiallyconflicting objectives of their partners whilealso educating them about the business. Ri-valry often becomes more unstable, and sinceproducers of complements can be potentialcompetitors, the threat of entry increases.

Another common form of partnering is out-sourcing. Internet technologies have made iteasier for companies to coordinate with theirsuppliers, giving widespread currency to thenotion of the “virtual enterprise”—a businesscreated largely out of purchased products,components, and services. While extensiveoutsourcing can reduce near-term costs andimprove flexibility, it has a dark side when itcomes to industry structure. As competitorsturn to the same vendors, purchased inputs be-come more homogeneous, eroding companydistinctiveness and increasing price competi-tion. Outsourcing also usually lowers barriersto entry because a new entrant need only as-semble purchased inputs rather than build itsown capabilities. In addition, companies losecontrol over important elements of their busi-ness, and crucial experience in components, as-sembly, or services shifts to suppliers, enhanc-ing their power in the long run.

The Future of Internet Competition While each industry will evolve in uniqueways, an examination of the forces influenc-ing industry structure indicates that the de-ployment of Internet technology will likelycontinue to put pressure on the profitability ofmany industries. Consider the intensity ofcompetition, for example. Many dot-coms aregoing out of business, which would seem to in-dicate that consolidation will take place andrivalry will be reduced. But while some consol-idation among new players is inevitable, manyestablished companies are now more familiarwith Internet technology and are rapidly de-ploying on-line applications. With a combina-

tion of new and old companies and generallylower entry barriers, most industries willlikely end up with a net increase in the num-ber of competitors and fiercer rivalry than be-fore the advent of the Internet.

The power of customers will also tend torise. As buyers’ initial curiosity with the Webwanes and subsidies end, companies offeringproducts or services on-line will be forced todemonstrate that they provide real benefits.Already, customers appear to be losing interestin services like Priceline.com’s reverse auctionsbecause the savings they provide are often out-weighed by the hassles involved. As customersbecome more familiar with the technology,their loyalty to their initial suppliers will alsodecline; they will realize that the cost ofswitching is low.

A similar shift will affect advertising-basedstrategies. Even now, advertisers are becomingmore discriminating, and the rate of growth ofWeb advertising is slowing. Advertisers can beexpected to continue to exercise their bargain-ing power to push down rates significantly,aided and abetted by new brokers of Internetadvertising.

Not all the news is bad. Some technologicaladvances will provide opportunities to en-hance profitability. Improvements in stream-ing video and greater availability of low-costbandwidth, for example, will make it easier forcustomer service representatives, or othercompany personnel, to speak directly to cus-tomers through their computers. Internet sell-ers will be able to better differentiate them-selves and shift buyers’ focus away from price.And services such as automatic bill paying bybanks may modestly boost switching costs. Ingeneral, however, new Internet technologieswill continue to erode profitability by shiftingpower to customers.

To understand the importance of thinkingthrough the longer-term structural conse-quences of the Internet, consider the businessof digital marketplaces. Such marketplaces au-tomate corporate procurement by linkingmany buyers and suppliers electronically. Thebenefits to buyers include low transactioncosts, easier access to price and product infor-mation, convenient purchase of associated ser-vices, and, sometimes, the ability to pool vol-ume. The benefits to suppliers include lowerselling costs, lower transaction costs, access towider markets, and the avoidance of powerful

page 9



channels.From an industry structure standpoint, the

attractiveness of digital marketplaces variesdepending on the products involved. The mostimportant determinant of a marketplace’sprofit potential is the intrinsic power of thebuyers and sellers in the particular productarea. If either side is concentrated or possessesdifferentiated products, it will gain bargainingpower over the marketplace and capture mostof the value generated. If buyers and sellersare fragmented, however, their bargainingpower will be weak, and the marketplace willhave a much better chance of being profitable.Another important determinant of industrystructure is the threat of substitution. If it isrelatively easy for buyers and sellers to trans-act business directly with one another, or to setup their own dedicated markets, independentmarketplaces will be unlikely to sustain highlevels of profit. Finally, the ability to createbarriers to entry is critical. Today, with dozensof marketplaces competing in some industriesand with buyers and sellers dividing their pur-chases or operating their own markets to pre-vent any one marketplace from gaining power,it is clear that modest entry barriers are a realchallenge to profitability.

Competition among digital marketplaces isin transition, and industry structure is evolv-ing. Much of the economic value created bymarketplaces derives from the standards theyestablish, both in the underlying technologyplatform and in the protocols for connectingand exchanging information. But once thesestandards are put in place, the added value ofthe marketplace may be limited. Anythingbuyers or suppliers provide to a marketplace,such as information on order specifications orinventory availability, can be readily providedon their own proprietary sites. Suppliers andcustomers can begin to deal directly on-linewithout the need for an intermediary. Andnew technologies will undoubtedly make iteasier for parties to search for and exchangegoods and information with one another.

In some product areas, marketplaces shouldenjoy ongoing advantages and attractive prof-itability. In fragmented industries such as realestate and furniture, for example, they couldprosper. And new kinds of value-added ser-vices may arise that only an independent mar-ketplace could provide. But in many productareas, marketplaces may be superceded by di-

rect dealing or by the unbundling of purchas-ing, information, financing, and logistical ser-vices; in other areas, they may be taken overby participants or industry associations as costcenters. In such cases, marketplaces will pro-vide a valuable “public good” to participantsbut will not themselves be likely to reap anyenduring benefits. Over the long haul, more-over, we may well see many buyers back awayfrom open marketplaces. They may once againfocus on building close, proprietary relation-ships with fewer suppliers, using Internet tech-nologies to gain efficiency improvements invarious aspects of those relationships.

The Internet and Competitive AdvantageIf average profitability is under pressure inmany industries influenced by the Internet, itbecomes all the more important for individualcompanies to set themselves apart from thepack—to be more profitable than the averageperformer. The only way to do so is by achiev-ing a sustainable competitive advantage—byoperating at a lower cost, by commanding apremium price, or by doing both. Cost andprice advantages can be achieved in two ways.One is operational effectiveness—doing thesame things your competitors do but doingthem better. Operational effectiveness advan-tages can take myriad forms, including bettertechnologies, superior inputs, better-trainedpeople, or a more effective managementstructure. The other way to achieve advantageis strategic positioning—doing things differ-ently from competitors, in a way that deliversa unique type of value to customers. This canmean offering a different set of features, a dif-ferent array of services, or different logisticalarrangements. The Internet affects opera-tional effectiveness and strategic positioningin very different ways. It makes it harder forcompanies to sustain operational advantages,but it opens new opportunities for achievingor strengthening a distinctive strategic posi-tioning.

Operational Effectiveness. The Internet isarguably the most powerful tool availabletoday for enhancing operational effective-ness. By easing and speeding the exchange ofreal-time information, it enables improve-ments throughout the entire value chain,across almost every company and industry.And because it is an open platform with com-

page 10



mon standards, companies can often tap intoits benefits with much less investment thanwas required to capitalize on past generationsof information technology.

But simply improving operational effective-ness does not provide a competitive advan-tage. Companies only gain advantages if theyare able to achieve and sustain higher levels ofoperational effectiveness than competitors.That is an exceedingly difficult propositioneven in the best of circumstances. Once a com-pany establishes a new best practice, its rivalstend to copy it quickly. Best practice competi-tion eventually leads to competitive conver-gence, with many companies doing the samethings in the same ways. Customers end upmaking decisions based on price, underminingindustry profitability.

The nature of Internet applications makes itmore difficult to sustain operational advan-tages than ever. In previous generations of in-formation technology, application develop-ment was often complex, arduous, timeconsuming, and hugely expensive. These traitsmade it harder to gain an IT advantage, butthey also made it difficult for competitors toimitate information systems. The openness ofthe Internet, combined with advances in soft-ware architecture, development tools, andmodularity, makes it much easier for compa-nies to design and implement applications.The drugstore chain CVS, for example, wasable to roll out a complex Internet-based pro-curement application in just 60 days. As thefixed costs of developing systems decline, thebarriers to imitation fall as well.

Today, nearly every company is developingsimilar types of Internet applications, oftendrawing on generic packages offered by third-party developers. The resulting improvementsin operational effectiveness will be broadlyshared, as companies converge on the sameapplications with the same benefits. Veryrarely will individual companies be able togain durable advantages from the deploymentof “best-of-breed” applications.

Strategic Positioning. As it becomes harderto sustain operational advantages, strategicpositioning becomes all the more important.If a company cannot be more operationally ef-fective than its rivals, the only way to generatehigher levels of economic value is to gain acost advantage or price premium by compet-ing in a distinctive way. Ironically, companies

today define competition involving the Inter-net almost entirely in terms of operational ef-fectiveness. Believing that no sustainable ad-vantages exist, they seek speed and agility,hoping to stay one step ahead of the competi-tion. Of course, such an approach to competi-tion becomes a self-fulfilling prophecy. With-out a distinctive strategic direction, speed andflexibility lead nowhere. Either no uniquecompetitive advantages are created, or im-provements are generic and cannot be sus-tained.

Having a strategy is a matter of discipline. Itrequires a strong focus on profitability ratherthan just growth, an ability to define a uniquevalue proposition, and a willingness to maketough trade-offs in choosing what not to do. Acompany must stay the course, even duringtimes of upheaval, while constantly improvingand extending its distinctive positioning. Strat-egy goes far beyond the pursuit of best prac-tices. It involves the configuration of a tailoredvalue chain—the series of activities required toproduce and deliver a product or service—thatenables a company to offer unique value. Tobe defensible, moreover, the value chain mustbe highly integrated. When a company’s activi-ties fit together as a self-reinforcing system,any competitor wishing to imitate a strategymust replicate the whole system rather thancopy just one or two discrete product featuresor ways of performing particular activities.(See the sidebar “The Six Principles of Strate-gic Positioning.”)

The Absence of StrategyMany of the pioneers of Internet business,both dot-coms and established companies,have competed in ways that violate nearlyevery precept of good strategy. Rather thanfocus on profits, they have sought to maxi-mize revenue and market share at all costs,pursuing customers indiscriminately throughdiscounting, giveaways, promotions, channelincentives, and heavy advertising. Rather thanconcentrate on delivering real value thatearns an attractive price from customers, theyhave pursued indirect revenues from sourcessuch as advertising and click-through feesfrom Internet commerce partners. Ratherthan make trade-offs, they have rushed tooffer every conceivable product, service, ortype of information. Rather than tailor thevalue chain in a unique way, they have aped

page 11



The Six Principles o

To establish and maintain a distinctegic positioning, a company needslow six fundamental principles.

First, it must start with the

right

perior long-term return on investmeby grounding strategy in sustainedability will real economic value be gated. Economic value is created whtomers are willing to pay a price foproduct or service that exceeds the producing it. When goals are defineterms of volume or market share leawith profits assumed to follow, poogies often result. The same is true wstrategies are set to respond to the ceived desires of investors.

Second, a company’s strategy muable it to deliver a

value proposition

,benefits, different from those that ctors offer. Strategy, then, is neitherfor the universally best way of compnor an effort to be all things to evertomer. It defines a way of competindelivers unique value in a particulauses or for a particular set of custom

Third, strategy needs to be reflec

distinctive value chain

. To establish aable competitive advantage, a commust perform different activities th

the activities of rivals. Rather than build andmaintain control over proprietary assets andmarketing channels, they have entered into arash of partnerships and outsourcing relation-ships, further eroding their own distinctive-ness. While it is true that some companieshave avoided these mistakes, they are excep-tions to the rule.

By ignoring strategy, many companies haveundermined the structure of their industries,hastened competitive convergence, and re-duced the likelihood that they or anyone elsewill gain a competitive advantage. A destruc-tive, zero-sum form of competition has beenset in motion that confuses the acquisition ofcustomers with the building of profitability.Worse yet, price has been defined as the pri-mary if not the sole competitive variable. In-stead of emphasizing the Internet’s ability tosupport convenience, service, specialization,customization, and other forms of value that

justify attractive prices, companies haveturned competition into a race to the bottom.Once competition is defined this way, it is verydifficult to turn back. (See the sidebar “Wordsfor the Unwise: The Internet’s Destructive Lex-icon.”)

Even well-established, well-run companieshave been thrown off track by the Internet.Forgetting what they stand for or what makesthem unique, they have rushed to implementhot Internet applications and copy the offer-ings of dot-coms. Industry leaders have com-promised their existing competitive advan-tages by entering market segments to whichthey bring little that is distinctive. MerrillLynch’s move to imitate the low-cost on-lineofferings of its trading rivals, for example, risksundermining its most precious advantage—itsskilled brokers. And many established compa-nies, reacting to misguided investor enthusi-asm, have hastily cobbled together Internet

f Strategic Positioningtive stra- to fol-

goal: su-nt. Only

profit-ener-

en cus-r a cost of d in dership, r strate-hen

per-

st en-

or set of ompeti- a quest eting

y cus-g that r set of

ers. ted in a

sustain-pany an rivals

or perform similar activities in different ways. A company must configure the way it conducts manufacturing, logistics, service delivery, marketing, human resource man-agement, and so on differently from rivals and tailored to its unique value proposition. If a company focuses on adopting best prac-tices, it will end up performing most activi-ties similarly to competitors, making it hard to gain an advantage.

Fourth, robust strategies involve trade-

offs. A company must abandon or forgo some product features, services, or activities in order to be unique at others. Such trade-offs, in the product and in the value chain, are what make a company truly distinctive. When improvements in the product or in the value chain do not require trade-offs, they often become new best practices that are imitated because competitors can do so with no sacrifice to their existing ways of competing. Trying to be all things to all cus-tomers almost guarantees that a company will lack any advantage.

Fifth, strategy defines how all the ele-ments of what a company does fit together. A strategy involves making choices through-out the value chain that are interdependent; all a company’s activities must be mutually

reinforcing. A company’s product design, for example, should reinforce its approach to the manufacturing process, and both should leverage the way it conducts after-sales service. Fit not only increases competi-tive advantage but also makes a strategy harder to imitate. Rivals can copy one activ-ity or product feature fairly easily, but will have much more difficulty duplicating a whole system of competing. Without fit, dis-crete improvements in manufacturing, mar-keting, or distribution are quickly matched.

Finally, strategy involves continuity of di-rection. A company must define a distinc-tive value proposition that it will stand for, even if that means forgoing certain opportu-nities. Without continuity of direction, it is difficult for companies to develop unique skills and assets or build strong reputations with customers. Frequent corporate “rein-vention,” then, is usually a sign of poor stra-tegic thinking and a route to mediocrity. Continuous improvement is a necessity, but it must always be guided by a strategic di-rection.

For a fuller description, see M.E. Porter, “What Is Strategy?” (HBR November–December 1996).

page 12



Words for the UnwisDestructive Lexicon

The misguided approach to competitiothat characterizes business on the Intenet has even been embedded in the language used to discuss it. Instead of talking in terms of strategy and competitivadvantage, dot-coms and other Interneplayers talk about “business models.” This seemingly innocuous shift in termnology speaks volumes. The definitionof a business model is murky at best. Most often, it seems to refer to a looseconception of how a company does buness and generates revenue. Yet simplhaving a business model is an exceed-ingly low bar to set for building a company. Generating revenue is a far cry from creating economic value, and nobusiness model can be evaluated inde-

units in a mostly futile effort to boost theirvalue in the stock market.

It did not have to be this way—and it doesnot have to be in the future. When it comes toreinforcing a distinctive strategy, tailoring ac-tivities, and enhancing fit, the Internet actu-ally provides a better technological platformthan previous generations of IT. Indeed, ITworked against strategy in the past. Packagedsoftware applications were hard to customize,and companies were often forced to changethe way they conducted activities in order toconform to the “best practices” embedded inthe software. It was also extremely difficult toconnect discrete applications to one another.Enterprise resource planning (ERP) systemslinked activities, but again companies wereforced to adapt their ways of doing things tothe software. As a result, IT has been a forcefor standardizing activities and speeding com-petitive convergence.

Internet architecture, together with otherimprovements in software architecture and de-velopment tools, has turned IT into a far morepowerful tool for strategy. It is much easier tocustomize packaged Internet applications to acompany’s unique strategic positioning. Byproviding a common IT delivery platformacross the value chain, Internet architectureand standards also make it possible to build

truly integrated and customized systems thatreinforce the fit among activities. (See the side-bar “The Internet and the Value Chain.”)

To gain these advantages, however, compa-nies need to stop their rush to adopt generic,“out of the box” packaged applications and in-stead tailor their deployment of Internet tech-nology to their particular strategies. Althoughit remains more difficult to customize pack-aged applications, the very difficulty of thetask contributes to the sustainability of the re-sulting competitive advantage.

The Internet as ComplementTo capitalize on the Internet’s strategic poten-tial, executives and entrepreneurs alike willneed to change their points of view. It hasbeen widely assumed that the Internet is can-nibalistic, that it will replace all conventionalways of doing business and overturn all tradi-tional advantages. That is a vast exaggeration.There is no doubt that real trade-offs can existbetween Internet and traditional activities. Inthe record industry, for example, on-linemusic distribution may reduce the need forCD-manufacturing assets. Overall, however,the trade-offs are modest in most industries.While the Internet will replace certain ele-ments of industry value chains, the completecannibalization of the value chain will be ex-ceedingly rare. Even in the music business,many traditional activities—such as findingand promoting talented new artists, produc-ing and recording music, and securing air-play—will continue to be highly important.

The risk of channel conflict also appears tohave been overstated. As on-line sales have be-come more common, traditional channels thatwere initially skeptical of the Internet haveembraced it. Far from always cannibalizingthose channels, Internet technology can ex-pand opportunities for many of them. Thethreat of disintermediation of channels ap-pears considerably lower than initially pre-dicted.

Frequently, in fact, Internet applications ad-dress activities that, while necessary, are notdecisive in competition, such as informing cus-tomers, processing transactions, and procuringinputs. Critical corporate assets—skilled per-sonnel, proprietary product technology, effi-cient logistical systems—remain intact, andthey are often strong enough to preserve ex-isting competitive advantages.

e: The Internet’s

n r---e t

i-

si-y

-

pendently of industry structure. The business model approach to manage-ment becomes an invitation for faulty thinking and self-delusion.

Other words in the Internet lexicon also have unfortunate consequences. The terms “e-business” and “e-strategy” have been particularly problematic. By encouraging managers to view their In-ternet operations in isolation from the rest of the business, they can lead to simplistic approaches to competing using the Internet and increase the pres-sure for competitive imitation. Estab-lished companies fail to integrate the In-ternet into their proven strategies and thus never harness their most important advantages.

page 13



The Internet and th

The basic tool for understanding the of information technology on companvalue chain—the set of activities throwhich a product or service is created ered to customers. When a company cin any industry, it performs a numbercrete but interconnected value-creatinties, such as operating a sales force, faa component, or delivering products,these activities have points of connecthe activities of suppliers, channels, atomers. The value chain is a framewoidentifying all these activities and anahow they affect both a company’s costvalue delivered to buyers.

Because every activity involves theprocessing, and communication of intion, information technology has a peinfluence on the value chain. The spevantage of the Internet is the ability toactivity with others and make real-timcreated in one activity widely availabwithin the company and with outsideers, channels, and customers. By incora common, open set of communicaticols, Internet technology provides a sized infrastructure, an intuitive browsface for information access and delive

In many cases, the Internet complements,rather than cannibalizes, companies’ tradi-tional activities and ways of competing. Con-sider Walgreens, the most successful pharmacychain in the United States. Walgreens intro-duced a Web site that provides customers withextensive information and allows them toorder prescriptions on-line. Far from cannibal-izing the company’s stores, the Web site hasunderscored their value. Fully 90% of custom-ers who place orders over the Web prefer topick up their prescriptions at a nearby storerather than have them shipped to their homes.Walgreens has found that its extensive net-work of stores remains a potent advantage,even as some ordering shifts to the Internet.

Another good example is W.W. Grainger, adistributor of maintenance products and spareparts to companies. A middleman with stock-ing locations all over the United States,Grainger would seem to be a textbook case ofan old-economy company set to be made obso-

lete by the Internet. But Grainger rejectedthe assumption that the Internet would un-dermine its strategy. Instead, it tightly coordi-nated its aggressive on-line efforts with its tra-ditional business. The results so far arerevealing. Customers who purchase on-linealso continue to purchase through othermeans—Grainger estimates a 9% incrementalgrowth in sales for customers who use the on-line channel above the normalized sales ofcustomers who use only traditional means.Grainger, like Walgreens, has also found thatWeb ordering increases the value of its physi-cal locations. Like the buyers of prescriptiondrugs, the buyers of industrial supplies oftenneed their orders immediately. It is faster andcheaper for them to pick up supplies at a localGrainger outlet than to wait for delivery.Tightly integrating the site and stocking loca-tions not only increases the overall value tocustomers, it reduces Grainger’s costs as well.It is inherently more efficient to take and pro-

e Value Chaininfluence ies is the

ugh and deliv-ompetes of dis-g activi-

bricating and tion with nd cus-rk for lyzing s and the

creation, forma-rvasive cial ad- link one e data

le, both suppli-porating

on proto-tandard-er inter-ry,

bidirectional communication, and ease of con-nectivity—all at much lower cost than private networks and electronic data interchange, or EDI.

Many of the most prominent applications of the Internet in the value chain are shown in the figure on the next page. Some involve moving physical activities on-line, while others involve making physical activities more cost effective.

But for all its power, the Internet does not represent a break from the past; rather, it is the latest stage in the ongoing evolution of infor-mation technology.1 Indeed, the technological possibilities available today derive not just from the Internet architecture but also from complementary technological advances such as scanning, object-oriented programming, re-lational databases, and wireless communica-tions.

To see how these technological improve-ments will ultimately affect the value chain, some historical perspective is illuminating.2 The evolution of information technology in business can be thought of in terms of five overlapping stages, each of which evolved out of constraints presented by the previous gener-ation. The earliest IT systems automated dis-crete transactions such as order entry and ac-

counting. The next stage involved the fuller automation and functional enhancement of in-dividual activities such as human resource management, sales force operations, and product design. The third stage, which is being accelerated by the Internet, involves cross-ac-tivity integration, such as linking sales activi-ties with order processing. Multiple activities are being linked together through such tools as customer relationship management (CRM), supply chain management (SCM), and enter-prise resource planning (ERP) systems. The fourth stage, which is just beginning, enables the integration of the value chain and entire value system, that is, the set of value chains in an entire industry, encompassing those of tiers of suppliers, channels, and customers. SCM and CRM are starting to merge, as end-to-end applications involving customers, channels, and suppliers link orders to, for example, man-ufacturing, procurement, and service delivery. Soon to be integrated is product development, which has been largely separate. Complex product models will be exchanged among par-ties, and Internet procurement will move from standard commodities to engineered items.

In the upcoming fifth stage, information technology will be used not only to connect

page 14



the various activities and playethe value system but to optimiworkings in real time. Choicesmade based on information frtiple activities and corporate eProduction decisions, for examautomatically factor in the capavailable at multiple facilities inventory available at multipleers. While early fifth-stage applwill involve relatively simple otion of sourcing, production, loand servicing transactions, thelevels of optimization will invo

• Real-time integrated scheduling, shipping,warehouse management,demand management and planning, and advanced planning andscheduling across the company and its suppliers

• Dissemination throughoutthe company of real-time inbound and in-progress inventory data

Technology Development• Collaborative product design acros• Knowledge directories accessible f• Real-time access by R&D to on-line

Human Resource Managemen• Self-service personnel and benefits• Web-based training• Internet-based sharing and dissem• Electronic time and expense repor

Firm Infrastructure• Web-based, distributed financial an• On-line investor relations (e.g., info

Inbound Logistics Operat• Integrat

exchangand decin-houseassembnents su

• Real-timpromiseto-promavailablforce an

• Web-distributed

Procurement• Internet-enabled demand planning• Other linkage of purchase, invento• Automated “requisition to pay”• Direct and indirect procurement v

Prominent Applicati

rs in ze its will be om mul-ntities. ple, will acity and the suppli-ications ptimiza-gistical, deeper lve the

product design itself. For example, product design will be optimized and customized based on input not only from factories and suppliers but also from customers.

The power of the Internet in the value chain, however, must be kept in perspective. While Internet applica-tions have an important influence on the cost and quality of activities, they are neither the only nor the dominant influence. Conventional factors such as scale, the skills of personnel, prod-uct and process technology, and in-

vestments in physical assets also play prominent roles. The Internet is trans-formational in some respects, but many traditional sources of competi-tive advantage remain intact.

1. See M.E. Porter and V.E. Millar, “How Information Gives You Competi-tive Advantage,” (HBR July–August 1985) for a framework that helps put the Internet’s current influence in con-text.2. This discussion is drawn from the author’s research with Philip Bligh.

s locations and among multiple value-system participantsrom all parts of the organization sales and service information

t administration

ination of company informationting

d ERP systemsrmation dissemination, broadcast conference calls)

ions Outbound Logistics Marketing and Sales After-Sales Serviceed information e, scheduling,ision making in plants, contract

lers, and compo-ppliers

e available-to- and capable-ise information e to the sales d channels

supply chain management

• Real-time transaction of orders whether initiated by an end consumer, asales person, or a channelpartner

• Automated customer-specific agreements and contract terms

• Customer and channel ac-cess to product develop-ment and delivery status

• Collaborative integrationwith customer forecastingsystems

• Integrated channel management including information exchange,warranty claims, and con-tract management (ver-sioning, process control)

• On-line sales channels including Web sites andmarketplaces

• Real-time inside and outside access to customerinformation, product cata-logs, dynamic pricing,inventory availability,on-line submission ofquotes, and order entry

• On-line product configurators

• Customer-tailored market-ing via customer profiling

• Push advertising

• Tailored on-line access

• Real-time customer feed-back through Web surveys,opt-in/opt-out marketing,and promotion responsetracking

• On-line support of customer service repre-sentatives through e-mail response management,billing integration, co-browse, chat,“call menow,” voice-over-IP, andother uses of videostreaming

• Customer self-servicevia Web sites and intelli-gent service request processing including updates to billing and shipping profiles

• Real-time field service access to customer account review, schematicreview, parts availabilityand ordering, work-orderupdate, and service partsmanagement

; real-time available-to-promise/capable-to-promise and fulfillmentry, and forecasting systems with suppliers

ia marketplaces, exchanges, auctions, and buyer-seller matching

ons of the Internet in the Value Chain

page 15



cess orders over the Web than to use tradi-tional methods, but more efficient to makebulk deliveries to a local stocking locationthan to ship individual orders from a centralwarehouse.

Grainger has also found that its printed cat-alog bolsters its on-line operation. Many com-panies’ first instinct is to eliminate printed cat-alogs once their content is replicated on-line.But Grainger continues to publish its catalog,and it has found that each time a new one isdistributed, on-line orders surge. The cataloghas proven to be a good tool for promoting theWeb site while continuing to be a convenientway of packaging information for buyers.

In some industries, the use of the Internetrepresents only a modest shift from well-estab-lished practices. For catalog retailers likeLands’ End, providers of electronic data inter-change services like General Electric, directmarketers like Geico and Vanguard, and manyother kinds of companies, Internet businesslooks much the same as traditional business. Inthese industries, established companies enjoyparticularly important synergies between theiron-line and traditional operations, which makeit especially difficult for dot-coms to compete.Examining segments of industries with charac-teristics similar to those supporting on-linebusinesses—in which customers are willing toforgo personal service and immediate deliveryin order to gain convenience or lower prices,for instance—can also provide an importantreality check in estimating the size of the Inter-net opportunity. In the prescription drug busi-ness, for example, mail orders representedonly about 13% of all purchases in the late1990s. Even though on-line drugstores maydraw more customers than the mail-orderchannel, it is unlikely that they will supplanttheir physical counterparts.

Virtual activities do not eliminate the needfor physical activities, but often amplify theirimportance. The complementarity between In-ternet activities and traditional activities arisesfor a number of reasons. First, introducing In-ternet applications in one activity often placesgreater demands on physical activities else-where in the value chain. Direct ordering, forexample, makes warehousing and shippingmore important. Second, using the Internet inone activity can have systemic consequences,requiring new or enhanced physical activitiesthat are often unanticipated. Internet-based

job-posting services, for example, have greatlyreduced the cost of reaching potential job ap-plicants, but they have also flooded employerswith electronic résumés. By making it easierfor job seekers to distribute résumés, the Inter-net forces employers to sort through manymore unsuitable candidates. The added back-end costs, often for physical activities, can endup outweighing the up-front savings. A similardynamic often plays out in digital market-places. Suppliers are able to reduce the trans-actional cost of taking orders when they moveon-line, but they often have to respond tomany additional requests for information andquotes, which, again, places new strains on tra-ditional activities. Such systemic effects under-score the fact that Internet applications arenot stand-alone technologies; they must be in-tegrated into the overall value chain.

Third, most Internet applications havesome shortcomings in comparison with con-ventional methods. While Internet technologycan do many useful things today and willsurely improve in the future, it cannot do ev-erything. Its limits include the following:

• Customers cannot physically examine,touch, and test products or get hands-on help inusing or repairing them.

• Knowledge transfer is restricted to codi-fied knowledge, sacrificing the spontaneity andjudgment that can result from interaction withskilled personnel.

• The ability to learn about suppliers andcustomers (beyond their mere purchasing hab-its) is limited by the lack of face-to-face contact.

• The lack of human contact with the cus-tomer eliminates a powerful tool for encourag-ing purchases, trading off terms and condi-tions, providing advice and reassurance, andclosing deals.

• Delays are involved in navigating sites andfinding information and are introduced by therequirement for direct shipment.

• Extra logistical costs are required to assem-ble, pack, and move small shipments.

• Companies are unable to take advantageof low-cost, nontransactional functions per-formed by sales forces, distribution channels,and purchasing departments (such as perform-ing limited service and maintenance functionsat a customer site).

• The absence of physical facilities circum-scribes some functions and reduces a means toreinforce image and establish performance.

page 16



Strategic Imperativ

At this critical juncture in the evolutionet technology, dot-coms and establispanies face different strategic imperatcoms must develop real strategies thaeconomic value. They must recognizerent ways of competing are destructivtile and benefit neither themselves noend, customers. Established companieturn, must stop deploying the Internestand-alone basis and instead use it tothe distinctiveness of their strategies.

The most successful dot-coms will fcreating benefits that customers will prather than pursuing advertising and through revenues from third parties. Tcompetitive, they will often need to wivalue chains to encompass other activsides those conducted over the Interndevelop other assets, including physicMany are already doing so. Some on-lers, for example, distributed paper catthe 2000 holiday season as an added cnience to their shoppers. Others are ining proprietary products under their o

• Attracting new customers is difficult giventhe sheer magnitude of the available informa-tion and buying options.

Traditional activities, often modified insome way, can compensate for these limits,just as the shortcomings of traditional meth-ods—such as lack of real-time information,high cost of face-to-face interaction, and highcost of producing physical versions of informa-tion—can be offset by Internet methods. Fre-quently, in fact, an Internet application and atraditional method benefit each other. For ex-ample, many companies have found that Websites that supply product information and sup-port direct ordering make traditional salesforces more, not less, productive and valuable.The sales force can compensate for the limitsof the site by providing personalized adviceand after-sales service, for instance. And thesite can make the sales force more productiveby automating the exchange of routine infor-mation and serving as an efficient new conduitfor leads. The fit between company activities, acornerstone of strategic positioning, is in thisway strengthened by the deployment of Inter-net technology.

Once managers begin to see the potential ofthe Internet as a complement rather than acannibal, they will take a very different ap-proach to organizing their on-line efforts.Many established companies, believing thatthe new economy operated under new rules,set up their Internet operations in stand-aloneunits. Fear of cannibalization, it was argued,would deter the mainstream organizationfrom deploying the Internet aggressively. Aseparate unit was also helpful for investor rela-tions, and it facilitated IPOs, tracking stocks,and spin-offs, enabling companies to tap intothe market’s appetite for Internet venturesand provide special incentives to attract Inter-net talent.

But organizational separation, while under-standable, has often undermined companies’ability to gain competitive advantages. By cre-ating separate Internet strategies instead of in-tegrating the Internet into an overall strategy,companies failed to capitalize on their tradi-tional assets, reinforced me-too competition,and accelerated competitive convergence. Bar-nes & Noble’s decision to establish Barnesand-noble.com as a separate organization is a vivid

es for Dot-Coms and Established Companies n of Inter-hed com-ives. Dot-t create that cur-e and fu-r, in the s, in

t on a enhance

ocus on ay for, click-o be

den their ities be-et and to al ones. ine retail-alogs for onve-troduc-wn

brand names, which not only boosts margins but provides real differentiation. It is such new activities in the value chain, not minor differ-ences in Web sites, that hold the key to whether dot-coms gain competitive advantages. AOL, the Internet pioneer, recognized these princi-ples. It charged for its services even in the face of free competitors. And not resting on initial advantages gained from its Web site and Inter-net technologies (such as instant messaging), it moved early to develop or acquire proprietary content.

Yet dot-coms must not fall into the trap of imitating established companies. Simply add-ing conventional activities is a me-too strategy that will not provide a competitive advantage. Instead, dot-coms need to create strategies that involve new, hybrid value chains, bringing to-gether virtual and physical activities in unique configurations. For example, E*Trade is plan-ning to install stand-alone kiosks, which will not require full-time staffs, on the sites of some cor-porate customers. VirtualBank, an on-line bank, is cobranding with corporations to create in-

house credit unions. Juniper, another on-line bank, allows customers to deposit checks at Mail Box Etc. locations. While none of these ap-proaches is certain to be successful, the strate-gic thinking behind them is sound.

Another strategy for dot-coms is to seek out trade-offs, concentrating exclusively on seg-ments where an Internet-only model offers real advantages. Instead of attempting to force the Internet model on the entire market, dot-coms can pursue customers that do not have a strong need for functions delivered outside the Inter-net—even if such customers represent only a modest portion of the overall industry. In such segments, the challenge will be to find a value proposition for the company that will distin-guish it from other Internet rivals and address low entry barriers.

Successful dot-coms will share the follow-ing characteristics:• Strong capabilities in Internet technology• A distinctive strategy vis-à-vis established

companies and other dot-coms, resting on a clear focus and meaningful advantages

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• Emphasis on creating customer valucharging for it directly, rather than ring on ancillary forms of revenue

• Distinctive ways of performing physfunctions and assembling non-Interassets that complement their strategsitions

• Deep industry knowledge to allow petary skills, information, and relatioships to be establishedEstablished companies, for the most pa

need not be afraid of the Internet—the prtions of their demise at the hands of dot-cwere greatly exaggerated. Established comnies possess traditional competitive advatages that will often continue to prevail; talso have inherent strengths in deployingnet technology.

The greatest threat to an established copany lies in either failing to deploy the Intor failing to deploy it strategically. Every cpany needs an aggressive program to depthe Internet throughout its value chain, uthe technology to reinforce traditional co

example. It deterred the on-line store fromcapitalizing on the many advantages providedby the network of physical stores, thus playinginto the hands of Amazon.

Rather than being isolated, Internet tech-nology should be the responsibility of main-stream units in all parts of a company. Withsupport from IT staff and outside consultants,companies should use the technology strategi-cally to enhance service, increase efficiency,and leverage existing strengths. While separateunits may be appropriate in some circum-stances, everyone in the organization musthave an incentive to share in the success of In-ternet deployment.

The End of the New EconomyThe Internet, then, is often not disruptive toexisting industries or established companies.It rarely nullifies the most important sourcesof competitive advantage in an industry; inmany cases it actually makes those sourceseven more important. As all companies cometo embrace Internet technology, moreover,the Internet itself will be neutralized as asource of advantage. Basic Internet applica-

tions will become table stakes—companieswill not be able to survive without them, butthey will not gain any advantage from them.The more robust competitive advantages willarise instead from traditional strengths suchas unique products, proprietary content, dis-tinctive physical activities, superior productknowledge, and strong personal service andrelationships. Internet technology may beable to fortify those advantages, by tying acompany’s activities together in a more dis-tinctive system, but it is unlikely to supplantthem.

Ultimately, strategies that integrate the In-ternet and traditional competitive advantagesand ways of competing should win in many in-dustries. On the demand side, most buyers willvalue a combination of on-line services, per-sonal services, and physical locations overstand-alone Web distribution. They will want achoice of channels, delivery options, and waysof dealing with companies. On the supply side,production and procurement will be more ef-fective if they involve a combination of Inter-net and traditional methods, tailored to strat-egy. For example, customized, engineered

e and ely-

ical net ic po-

ropri-n-

rt, edic-oms

pa-n-hey Inter-

m-ernet om-loy sing mpeti-

tive advantages and complement existing ways of competing. The key is not to imitate rivals but to tailor Internet applications to a com-pany’s overall strategy in ways that extend its competitive advantages and make them more sustainable. Schwab’s expansion of its brick-and-mortar branches by one-third since it started on-line trading, for example, is extend-ing its advantages over Internet-only competi-tors. The Internet, when used properly, can support greater strategic focus and a more tightly integrated activity system.

Edward Jones, a leading brokerage firm, is a good example of tailoring the Internet to strat-egy. Its strategy is to provide conservative, per-sonalized advice to investors who value asset preservation and seek trusted, individualized guidance in investing. Target customers in-clude retirees and small-business owners. Ed-ward Jones does not offer commodities, fu-tures, options, or other risky forms of investment. Instead, the company stresses a buy-and-hold approach to investing involving mutual funds, bonds, and blue-chip equities.

Edward Jones operates a network of about 7,000 small offices, which are located conve-niently to customers and are designed to en-courage personal relationships with brokers.

Edward Jones has embraced the Internet for internal management functions, recruiting (25% of all job inquiries come via the Internet), and for providing account statements and other information to customers. However, it has no plan to offer on-line trading, as its com-petitors do. Self-directed, on-line trading does not fit Jones’s strategy nor the value it aims to deliver to its customers. Jones, then, has tai-lored the use of the Internet to its strategy rather than imitated rivals. The company is thriving, outperforming rivals whose me-too In-ternet deployments have reduced their distinc-tiveness.

The established companies that will be most successful will be those that use Internet tech-nology to make traditional activities better and those that find and implement new combina-tions of virtual and physical activities that were not previously possible.

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inputs will be bought directly, facilitated by In-ternet tools. Commodity items may be pur-chased via digital markets, but purchasing ex-perts, supplier sales forces, and stockinglocations will often also provide useful, value-added services.

The value of integrating traditional and In-ternet methods creates potential advantagesfor established companies. It will be easier forthem to adopt and integrate Internet methodsthan for dot-coms to adopt and integrate tradi-tional ones. It is not enough, however, just tograft the Internet onto historical ways of com-peting in simplistic “clicks-and-mortar” config-urations. Established companies will be mostsuccessful when they deploy Internet technol-ogy to reconfigure traditional activities orwhen they find new combinations of Internetand traditional approaches.

Dot-coms, first and foremost, must pursuetheir own distinctive strategies, rather thanemulate one another or the positioning of es-tablished companies. They will have to breakaway from competing solely on price and in-stead focus on product selection, product de-sign, service, image, and other areas in whichthey can differentiate themselves. Dot-comscan also drive the combination of Internet andtraditional methods. Some will succeed by cre-ating their own distinctive ways of doing so.Others will succeed by concentrating on mar-ket segments that exhibit real trade-offs be-tween Internet and traditional methods—ei-ther those in which a pure Internet approachbest meets the needs of a particular set of cus-tomers or those in which a particular productor service can be best delivered without theneed for physical assets. (See the sidebar “Stra-tegic Imperatives for Dot-Coms and Estab-lished Companies.”)

These principles are already manifestingthemselves in many industries, as traditionalleaders reassert their strengths and dot-comsadopt more focused strategies. In the broker-age industry, Charles Schwab has gained alarger share (18% at the end of 1999) of on-linetrading than E*Trade (15%). In commercialbanking, established institutions like WellsFargo, Citibank, and Fleet have many more

on-line accounts than Internet banks do. Estab-lished companies are also gaining dominanceover Internet activities in such areas as retail-ing, financial information, and digital market-places. The most promising dot-coms are lever-aging their distinctive skills to provide realvalue to their customers. ECollege, for exam-ple, is a full-service provider that works withuniversities to put their courses on the Inter-net and operate the required delivery networkfor a fee. It is vastly more successful than com-petitors offering free sites to universities undertheir own brand names, hoping to collect ad-vertising fees and other ancillary revenue.

When seen in this light, the “new economy”appears less like a new economy than like anold economy that has access to a new technol-ogy. Even the phrases “new economy” and“old economy” are rapidly losing their rele-vance, if they ever had any. The old economyof established companies and the new econ-omy of dot-coms are merging, and it will soonbe difficult to distinguish them. Retiring thesephrases can only be healthy because it will re-duce the confusion and muddy thinking thathave been so destructive of economic valueduring the Internet’s adolescent years.

In our quest to see how the Internet is dif-ferent, we have failed to see how the Internetis the same. While a new means of conductingbusiness has become available, the fundamen-tals of competition remain unchanged. Thenext stage of the Internet’s evolution will in-volve a shift in thinking from e-business tobusiness, from e-strategy to strategy. Only byintegrating the Internet into overall strategywill this powerful new technology become anequally powerful force for competitive advan-tage.

The author is grateful to Jeffrey Rayport and tothe Advanced Research Group at Inforte for theircontributions to this article.

Reprint R0103D; Harvard Business Review OnPoint 6358To order, see the next pageor call 800-988-0886 or 617-783-7500or go to www.hbr.org

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Further Reading

A R T I C L E SWhat Is Strategy? by Michael E. PorterHarvard Business ReviewNovember-December 1996Product no. 4134

In this article, Porter sharpens the focus on the two components of sustainable competitive advantage discussed in “Strategy and the In-ternet”: operational effectiveness and strategic positioning. He emphasizes that it’s strategic positioning, not operational effectiveness, that lets a company most effectively distinguish it-self from competitors. He then outlines three key principles behind strategic positioning: 1) creating a unique, valuable position through serving a few needs of many customers, broad needs of a few customers, or broad needs of many customers; 2) making trade-offs in com-petition (i.e., choosing what not to do); and—most relevant to his discussion of integration in “Strategy and the Internet”—3) improving “fit” among the company’s activities so that they reinforce one another. As he explains, when a company’s activities reinforce one an-other in a tightly interlocked system, competi-tors can’t easily imitate that system.

Strategy as Simple Rules by Kathleen M. Eisenhardt and Donald N. Sull Harvard Business ReviewNovember-December 1996Product no. 5858

This article provides practical guidelines for strengthening your company’s strategic posi-tioning. Like Porter, Eisenhardt and Sull em-phasize the importance of strategy in today’s unpredictable, complex markets. They empha-size keeping strategy clear and simple by fo-cusing on a unique set of strategic pro-cesses—e.g., product innovation, partnering, branding—that place your company where the flow of opportunities is swiftest and deep-est, and then defining just a handful of simple

rules to guide those processes. The authors outline five kinds of rules, including mandates for quickly ranking competing opportunities, deciding when to pull the plug on an opportu-nity, and distinctively executing your key pro-cesses.

B O O KOn Competition by Michael E. PorterHarvard Business School Press1998Product no. 7951

This book—a collection of Porter’s articles from the Harvard Business Review, augmented by two new selections and an introduction—is a more expansive treatment of Porter’s per-spectives on the core concepts of competition and strategy, which he refers to in “Strategy and the Internet.” He shows how crucial busi-ness activities, such as staking out and main-taining a distinctive competitive position and continually improving productivity, are inti-mately linked to strategic positioning.

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