1. The Strategic Potential of the Internet (Part One) Presented by Derek Lee CIS 590 Spring 2008

2. Agenda Background of Michael E. Porter Background of the Internet Purposes of the Chapter Structure of the Chapter Questions and Comments 2

3. Background of Michael E. Porter Author: Dr. Michael Eugene Porter Is a Harvard professor teaching management & economics Academic objectives focus on competitive advantage & strategy Has made important contributions to strategic management & strategy theory “The Godfather of organization strategy” MBA students should know who he is! 3

4. Agenda Background of Michael E. Porter Background of the Internet Purposes of the Chapter Structure of the Chapter Questions and Comments 4

5. Background of the Internet After its expansion into popular use in 1990s, the Internet has had a drastic impact on culture and commerce The Internet has become an extremely important technology worldwide Many companies nowadays know that they need to deploy Internet technology, but don’t know how to utilize it to lead their business more profitable 5

6. Agenda Background of Michael E. Porter Background of the Internet Purposes of the Chapter Structure of the Chapter Questions and Comments 6

7. Purposes of the Chapter The Internet … is an enabling technology has caused negative effects on industries reduces the ability to establish and sustain a competitive advantage Emphasis that strategy is critical 7

8. Agenda Background of Michael E. Porter Background of the Internet Purposes of the Chapter Structure of the Chapter Questions and Comments 8

9. Structure of the Chapter Distorted market signals Return to fundamentals The Internet and industry structure The myth of the first mover The future of Internet competition The Internet and competitive advantage The absence of strategy The Internet as complement The end of the new economy Presented by Jay Krishna 9

10. Why distorted market signals? Revenues are unreliable Companies subsidize the purchase of their products and services, so do the governments on sales taxes Buyers are willing to conduct transactions online even when the benefits are uncertain or limited Some revenues from online commerce are received in the form of stock rather than cash Distorted Market Signals 10

11. Distorted Market Signals Other reasons? Masking true costs Suppliers learn from dot-com leaders, providing heavy discounts on products and services They accept equity or stock options from Internet- related ventures in payment for products or services Even more unreliable stock market Stock valuations become separated from business fundamentals, so no longer provide an accurate guide These companies put themselves at risk! 11

12. Distorted Market Signals Conclusions of distorted market signals by Internet-related companies: Executives downplay traditional measures of profitability and economic value Creative accounting approaches are developed Consequences of distorted market signals True financial performance of many Internet-related businesses is worse than it is stated Dot-coms can easily raise capital without having to demonstrate viability 12

13. Return to Fundamentals The creation of true economic value turns to be the final judge of business success, as only old rules can regain prevalence 13 Is a company’s current stock price necessarily an indicator of true economic value? No! Economic value of an Internet-related company can be determined by: The uses of the Internet

14. So how can the Internet be used to create economic value? Two fundamental factors determining profitability 1. Industry structure – determines the profitability of the average competitors 2. Sustainable competitive advantage – allows a company to outperform the average competitors Return to Fundamentals 14

15. How Internet benefits to the industries: The Internet has created some new industries Online auctions (Ebay.com) Digital marketplaces (Craigslist.org) Allowed existing industries to be reconfigured Expand distance learning or meeting (Webex.com) Provide efficient means to order products (Pizzahut.com) Benefits vary widely by industry and company (Less benefit on local dentistry) The Internet and Industry Structure 15

16. The Internet and Industry Structure How to determine the profitability of the average competitors? By five underlying forces of competition Porter’s five forces model These forces determine how the economic value created by any product, service, technology, or way of competing is divided between companies and their stakeholders or competitors 16

17. The Internet and Industry Structure Porter’s Five Forces Model 17 Rivalry among existing customers Barriers to entry Threat of substitutes products or services Bargaining power of suppliers Bargaining power of buyers

18. The Myth of the First Mover Everyone tends to focus on: what the Internet could do and how quickly its use was expanding, rather than on how it was affecting industry structure Widespread belief is that: the Internet would release from forces that would enhance industry profitability General assumptions that Internet would: increase switching costs create strong network effects 18

19. The Myth of the First Mover Switching costs Include all the costs incurred by a customer in changing to a new supplier Switching costs   Customer’s bargaining power   Barriers to entry into an industry  Myth: Internet  switching costs Able to collect knowledge of buying behavior Reality: Internet  switching costs Buyers can switch suppliers with just a few mouse clicks 19

20. The Myth of the First Mover Conclusion of Switching costs Switching costs   Customer’s bargaining power   Barriers to entry into an industry  Example: Widespread adoption of PayPal and XML PayPal  The Internet currency enables customers to shop at different Websites without providing personal information and credit card or bank account numbers XML  The XML standards will free companies from the need to reconfigure order systems and to create new protocols when changing suppliers 20

21. Network Effects A number of important Internet applications display network effects, such as email, instant messaging, auctions, and online message boards or chat rooms Myth: Network effects are significant They can create demand-side economies of sales and raise barriers to entry Reality: It is not enough for Network effects to provide barriers to entry The openness of the Internet, with it common standards and protocols and its eases of navigation, makes it difficult for a single company to capture the benefits of a network effects 21 The Myth of the First Mover

22. Other myths for the Internet include: Internet brands could be easily built Partnering is a win-win means to improve industry economics due to the complements In reality: Internet brands have proven difficult to build Lack of physical presence and direct human contact Complements affect industry profitability indirectly through their influence on the five competitive forces If a complement works to standardize the industry’s product offering, it will increase rivalry and depress profitability 22 The Myth of the First Mover

23. The Future of Internet Competition The deployment of Internet technology will likely continue to put pressure on the profitability of many industries Under the intensity of competition, many dot-coms are going out of business The power of customers will also tend to rise Example: Customers appear to be losing interest in reverse auctions such as Priceline.com Customers’ loyalty to their initial suppliers will decline Because they realize that the switching cost is low 23

24. The Future of Internet Competition But not all about the Internet are bad! Some technological advances will provide opportunities to enhance profitability Streaming video Low-cost bandwidth Benefits: Easier for customer service reps to speak directly to customers through their computers Internet sellers are able to better differentiate themselves and shift buyers’ focus away from price Auto bill pay by banks may modestly boost up their customers’ switching costs 24

25. The Future of Internet Competition Longer-term structural consequences of the Internet: 25 Benefits to buyers Low transaction costs Easier access to price & product info Convenient purchase of associated services Ability to pool volume Benefits to suppliers Lower selling costs Lower transaction costs Access to wider markets Avoidance of powerful channels But the new Internet technologies still continue to wear down companies’ profitability by shifting power to customers

26. The Internet and Competitive Advantage If profitability is under pressure influenced by the Internet, individual companies can be survived by achieving a sustainable competitive advantage By operating at a lower cost By commanding a premium price Two ways to achieve cost and price advantages Operational effectiveness Strategic positioning 26

27. Operational Effectiveness Internet is claimed to be the most powerful tool for enhancing operational effectiveness Easing and speeding the exchange of real-time information An open platform with common standards But simply improving operational effectiveness does not provide a competitive advantage Only if the companies can sustain higher levels of operational effectiveness than competitors, which is very difficult Even if it can achieve, it is still easy for competitors to imitate The result is: Customers end up making decisions based on price, undermining industry profitability 27

28. Strategic Positioning As it becomes harder to sustain operational advantages, strategic positioning becomes more important Without a distinctive strategic direction … No unique competitive advantages are create Improvement are generic and cannot be sustain Requires a strong focus on profitability rather than just growth Value chain must be highly integrated  enables a company to offer unique value during production and delivery of a product or service 28 You may ask … Can competitors also imitate the company’s distinctive strategy, just like how to imitate the operational effectiveness? Answer is still yes, but is much harder! Competitors wishing to imitate a strategy must replicate the whole system rather than just copy one or two product features.

29. Strategic Positioning To establish and maintain a distinctive strategic positioning, a company should follow six fundamental principles: Start with the right goal  long-term ROI Deliver a unique value proposition Develop a distinctive value chain Make trade-offs  forgo something Ensure all elements fitting together Have continuity of direction 29

30. Agenda Background of Michael E. Porter Background of the Internet Purposes of the Chapter Structure of the Chapter Questions and Comments 30

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