NBA 600: Session 3 Strategy and the Internet 28 January 2003

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NBA 600 Session 3Strategy and the Internet
28 January 2003

• Daniel Huttenlocher

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Todays Class

• Finish Thursdays discussion on structure of the
  Internet
• Clarification Internet routers make local
  decisions about where to send packets
• Packets just have addresses, not active
• Payment models
• Start discussion of Porter-Tapscott debate on
  strategy and the Internet
• Porter argues the Internet is like any other IT
  advance of the past 25 years
• Tapscott argues it is a fundamental change, like
  electricity or railroads

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Recall Internet Structure

• 1 The Internet is a collection of networks
• Held together by standard protocols (TCP)
• Like road networks
• Local, county, state, national
• Agree on where to connect and how to drive
• 2 Packed switched data
• Information broken up into small packets each
  addressed separately to the recipient
• Unique addresses IP address
• Like filling up envelopes and sending to same
  address
• Each is routed separately, reassemble at end

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Payment Structure of the Internet

• End-users pay for bandwidth
• 20/mo 56kb dialup (consumer)
• 40/mo 128kb upstream - 768kb downstream
  broadband (consumer)
• 900/mo 1.6mb T1 (commercial)
• 40k/mo 155mb OC3 (commercial)
• Commercial users tend make higher use
• Asymmetric broadband market segmentation
• Some leases charge for usage over given level
• Each of these categories generates 100s
  millions of monthly revenue

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How Internet is Constructed

• Each network provider (ISP) builds its own
  network
• Chooses what other network(s) to connect to
• Chooses what traffic to accept from connected
  network(s)
• Pairwise peering arrangements govern what
  inter-network traffic will be carried
• Sometimes involves charges, sometimes involves
  trades local decisions by two ISPs
• Each ISP motivated to provide connectivity needed
  by their customers

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Connectivity of Internet and Web

• Evolutionary rather than designed
• Shows many patterns similar to natural or
  organic growth phenomena
• E.g., neurons, six degrees of Kevin Bacon
• Good routes evolve through needs of end-users
• Any two hosts about 15 hops (degrees) apart
• Aside analogous structure in hyperlinks between
  Web pages
• This structure is used for search engines, e.g.,
  Google

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Geo-Location in Internet

• The cabling and routers (connections) of the
  Internet are in physical locations
• Often in or near big cities where the traffic is
• These physical locations are not evident in the
  IP addressing scheme
• Companies sell services that try to determine
  geo-location from IP address
• For marketing, security, legal and other uses
• Large service providers need to combat physical
  location
• Packet transit times in the network too slow
• Potential for congestion with single site

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Reflect Conclusions We Can Draw

• Relentless, organic, drive to connectivity
• Services that do not connect to the Internet are
  at risk
• Case of AOLs free AIM client
• What does this say about text messaging
• Consider Blackberry/RIM or Bloomberg messaging
  niche businesses
• Global, highly interactive services need multiple
  physical locations in the network
• Simply slow if interacting users far apart
• Pricing models differentiate consumer and
  commercial use

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Porter Strategy and Internet

• Internet has been used as excuse to ignore
  strategy yielded bad decisions
• Forfeit proprietary advantage by rushing online
• Focus on price rather than quality/features
• Winners will use Internet as complement to, not
  cannibal of, traditional competition
• Simply another step in IT evolution, like object
  oriented programming or relational databases
• Internet not necessarily a blessing
• Tends to dampen profitability and have leveling
  effect on business practices

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Porter Internet Trends

• Rising power of customers
• Better informed, easier comparison/substitutes
• Lower switching costs, less loyalty
• Real value not just gimmicks
• E.g., Priceline model has limited appeal
• Note PCLN reports selling price as revenue
  (about 1B vs. EXPE 750M of commissions)
• First-mover not an advantage
• Dis-intermediation not much of a threat
• Enhancing operational effectiveness
• Decrease in communication/coordination costs

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Porter On Business Models

• Destructive way of thinking
• Loose terminology, far cry from creating economic
  value
• Invitation to faulty thinking and self delusion
• What matters is strategy
• Critical to consider competitive forces and
  industry structure
• Notions of e-business and e-strategy similarly
  problematic
• Encourage consideration of Internet in isolation
  rather than as complement to existing business

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Tapscott Internet Changes Things

• The Internet provides a fundamental improvement
  in communication
• Improves outsourcing, contract manufacturing
• Enables true sales partnerships
• Challenges industrial age corporate structure
• Porter takes a truth and misapplies it
• The truth profitability matters
• Not eyeballs, hits, stickiness, etc.
• But does not support false thesis that Internet
  is simply another incremental change
• Business as usual vertically integrated corp.

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Tapscott Impact of Internet

• An added piece of the wealth creation
  infrastructure
• Power grid, railroads/highways, telephone
• Now the Internet too
• Internet growing to take over or connect to most
  other communication mechanisms
• Voice over IP, Internet radio, cell phones
• Distribution of content print, audio, video
• Internet enables new business models
• Strategy has tended to ignore, because
  traditionally each industry has a fixed model

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Tapscotts B Webs

• Companies that draw on all resources to create
  profitable business
• Deep partnerships
• Only possible through Internet communication
• E.g., coordinating joint sales efforts between
  two companies
• Example of IBM customer relationship management
  (CRM) business
• Dropped own software, partnered with Siebel and
  others joint selling services
• Now multi-billion dollar business for IBM
• Also driving hundreds of millions of DB2 sales!

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Analysis of the Debate

• Agree on some terminology
• Strategy being profitable by choosing what to do
  and what not to do
• Consistent direction not all things to all
  people
• Based on analyzing structure of industry
• Competitors, suppliers, customers, new entrants,
  substitutes
• Business model where the revenue is going to
  come from
• Who will pay, for what, when, why, how much?
• Operations doing better at what doing
• Industry-wide best practices

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What do You Think?

• Have I mis-characterized Porter or Tapscotts
  positions?
• Missed something important?
• Have they mis-characterized each other?
• Where do they agree more than they might
  initially appear to?
• Who or what do you think is right?
• What do you think is really going on regarding
  strategy and the Internet?
• Support arguments with company examples or your
  own experience

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Internet Changes Landscape

• Increases need for strategy
• Increases bargaining power of customers
• Can decrease bargaining power of suppliers
• Either lowers or raises switching costs
• Change to substitutes generally easier, except in
  industries where network effects
• Less clear general effects on barriers to entry
  or competitors
• Creates need to consider business models
• May enable new sources of revenue or undermine
  current sources

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First Mover Myth

• Being there first does not by itself provide much
  advantage
• E.g., Priceline was early in online travel
• But its model not what people wanted
• Even for business with network effects
• Where customers benefit from a single product or
  service (e.g., computer software)
• Though eBay has exploited this
• Good strategy and execution what count
• Provide what customer wants, deliver more
  effectively

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First Mover Myth Beyond Internet

• Betamax vs. VHS videotape formats
• Huge network effect for rental market
• Started as on-air recording business shifted
• Sonys go-it-alone strategy lost to consortium
• Microsoft repeated dominance
• DOS vs. CPM, Windows vs. Mac or OS/2, IE vs.
  Netscape, Excel vs. 123, Word vs. Wordperfect/
  Winstar,
• HP dominance of laser printer market
• Invented by Xerox but didnt want to undercut
  high end printing business

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Internet and Bargaining Power

• Provides vastly improved ability to search and
  compare
• Uncensored public opinion
• Advertising and product descriptions
• Discounted pricing
• Empowers purchasers
• Both consumers and companies
• Tilts balance so that suppliers become weaker and
  customers become stronger
• Exceptions where effective monopolies

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Internet and Industry Structure

• Fundamental changes to any content creation or
  distribution business
• Music, movies, telephone, broadcasting,
• Digital content opens totally new means of
  distribution and protection
• Technologically possible to control the
  experience of the content after purchase
• E.g., force watching previews on DVDs
• Experts able to circumvent controls
• Possibility of unfettered illicit copying
• Raging battle over degree of control

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Internet Substitutes

• Newspaper industry major source of revenue is
  classifieds (about 20B/yr)
• Web provides substitute for classifieds
• Arguably better once credible
• What is happening, where might it end up
• Collectibles already have moved to eBay
• But were low revenue for newspapers
• Employment moving to Monster, Yahoo
• Perhaps not yet replacing, but high revenue risk
• Real estate still strong, but online just
  starting
• Major revenue source

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Substitutes Online vs. Offline

• Book sales
• Amazon dominates the online market
• Borders strategy is to supplement stores
• Outsourced online sales to Amazon
• Prominent link to stores site
• Provide access to store inventory
• Competitive advantages and disadvantages
• Does attraction of in stock over-ride
  disadvantages of out of stock
• Barnes and Noble separates businesses
• Only offer online directions and in store returns

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Internet and Outsourcing

• Contract manufacturing
• Has become a large business
• Top 5 over 50B annual revenue
• Requires close interaction, facilitated by
  Internet
• Outsourcing of operations functions
• Travel, benefits management done on Web
• Joint sales
• IBM has been champion in this regard
• Solutions and business bundles hardware,
  software, services
• Joint selling with other vendors

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Summing Up

• Importance of Internet to strategy
• Changes to industry structure require strategic
  analysis that accounts for effects
• Internet does change the rules in many industries
• But primarily changes that are well handled by
  strategic analysis
• Customers, suppliers, competitors, substitutes,
  new entrants
• First mover advantage does not exist
• Business models are more important now

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Next Time

• Discuss business models and the Internet
• What business models are, how they are important
• Relationship to strategy
• Clear articulation of industry business model(s)
  and potential alternatives
• Especially alternatives enabled or facilitated by
  Internet
• New models are rare, but that doesnt make it any
  less important to consider