16 Apr 2001  Research & Ideas

Strategy and the Internet

Don't throw the strategy baby out with the Internet bath water. In this Harvard Business Review article, HBS professor Michael E. Porter urges business planners not to lose focus on strategic development and competitive advantage, but to recognize the Internet for what it is: "an enabling technology."

 

If average profitability is under pressure in many industries influenced by the Internet, it becomes all the more important for individual companies to set themselves apart from the pack—to be more profitable than the average performer. The only way to do so is by achieving a sustainable competitive advantage—by operating at a lower cost, by commanding a premium price, or by doing both. Cost and price advantages can be achieved in two ways. One is operational effectiveness—doing the same things your competitors do but doing them better. Operational effectiveness advantages can take myriad forms, including better technologies, superior inputs, better trained people, or a more effective management structure. The other way to achieve advantage is strategic positioning—doing things differently from competitors, in a way that delivers a unique type of value to customers. This can mean offering a different set of features, a different array of services, or different logistical arrangements. The Internet affects operational effectiveness and strategic positioning in very different ways. It makes it harder for companies to sustain operational advantages, but it opens new opportunities for achieving or strengthening a distinctive strategic positioning.

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

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

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

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

Strategic Positioning. As it becomes harder to sustain operational advantages, strategic positioning becomes all the more important. If a company cannot be more operationally effective than its rivals, the only way to generate higher levels of economic value is to gain a cost advantage or price premium by competing in a distinctive way. Ironically, companies today define competition involving the Internet almost entirely in terms of operational effectiveness. Believing that no sustainable advantages exist, they seek speed and agility, hoping to stay one step ahead of the competition. Of course, such an approach to competition becomes a self-fulfilling prophecy. Without a distinctive strategic direction, speed and flexibility lead nowhere. Either no unique competitive advantages are created, or improvements are generic and cannot be sustained.

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

Having a strategy is a matter of discipline. It requires a strong focus on profitability rather than just growth, an ability to define a unique value proposition, and a willingness to make tough trade-offs in choosing what not to do.
—Michael E. Porter

The Absence of Strategy

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

By ignoring strategy, many companies have undermined the structure of their industries, hastened competitive convergence, and reduced the likelihood that they or anyone else will gain a competitive advantage. A destructive, zero-sum form of competition has been set in motion that confuses the acquisition of customers with the building of profitability. Worse yet, price has been defined as the primary if not the sole competitive variable. Instead of emphasizing the Internet's ability to support convenience, service, specialization, customization, and other forms of value that justify attractive prices, companies have turned competition into a race to the bottom. Once competition is defined this way, it is very difficult to turn back.

Even well-established, well-run companies have been thrown off track by the Internet. Forgetting what they stand for or what makes them unique, they have rushed to implement hot Internet applications and copy the offerings of dot-coms. Industry leaders have compromised their existing competitive advantages by entering market segments to which they bring little that is distinctive. Merrill Lynch's move to imitate the low-cost on-line offerings of its trading rivals, for example, risks undermining its most precious advantage—its skilled brokers. And many established companies, reacting to misguided investor enthusiasm, have hastily cobbled together Internet units in a mostly futile effort to boost their value in the stock market.

It did not have to be this way—and it does not have to be in the future. When it comes to reinforcing a distinctive strategy, tailoring activities, and enhancing fit, the Internet actually provides a better technological platform than previous generations of IT. Indeed, IT worked against strategy in the past. Packaged software applications were hard to customize, and companies were often forced to change the way they conducted activities in order to conform to the "best practices" embedded in the software. It was also extremely difficult to connect discrete applications to one another. Enterprise resource planning (ERP) systems linked activities, but again companies were forced to adapt their ways of doing things to the software. As a result, IT has been a force for standardizing activities and speeding competitive convergence.

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

To gain these advantages, however, companies need to stop their rush to adopt generic, "out of the box" packaged applications and instead tailor their deployment of Internet technology to their particular strategies. Although it remains more difficult to customize packaged applications, the very difficulty of the task contributes to the sustainability of the resulting competitive advantage.

The Six Principles of Strategic Positioning

To establish and maintain a distinctive strategic positioning, a company needs to follow six fundamental principles.

First, it must start with the right goal: superior long-term return on investment. Only by grounding strategy in sustained profitability will real economic value be generated. Economic value is created when customers are willing to pay a price for a product or service that exceeds the cost of producing it. When goals are defined in terms of volume or market share leadership, with profits assumed to follow, poor strategies often result. The same is true when strategies are set to respond to the perceived desires of investors.

Second, a company's strategy must enable it to deliver a value proposition, or set of benefits, different from those that competitors offer. Strategy, then, is neither a quest for the universally best way of competing nor an effort to be all things to every customer. It defines a way of competing that delivers unique value in a particular set of uses or for a particular set of customers.

Third, strategy needs to be reflected in a distinctive value chain. To establish a sustainable competitive advantage, a company must perform different activities than rivals or perform similar activities in different ways. A company must configure the way it conducts manufacturing, logistics, service delivery, marketing, human resource management, and so on differently from rivals and tailored to its unique value proposition. If a company focuses on adopting best practices, it will end up performing most activities 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 customers almost guarantees that a company will lack any advantage.

Fifth, strategy defines how all the elements of what a company does fit together. A strategy involves making choices throughout 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 competitive advantage but also makes a strategy harder to imitate. Rivals can copy one activity or product feature fairly easily, but will have much more difficulty duplicating a whole system of competing. Without fit, discrete improvements in manufacturing, marketing, or distribution are quickly matched.

Finally, strategy involves continuity of direction. A company must define a distinctive value proposition that it will stand for, even if that means forgoing certain opportunities. Without continuity of direction, it is difficult for companies to develop unique skills and assets or build strong reputations with customers. Frequent corporate "reinvention; then, is usually a sign of poor strategic thinking and a route to mediocrity. Continuous improvement is a necessity, but it must always be guided by a strategic direction.

Excerpted with permission from "Strategy and the Internet," Harvard Business Review, Vol. 79, No. 3, March 2001.

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