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

NBA 600: Session 3Strategy and the Internet

28 January 2003

Daniel Huttenlocher

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Today’s Class

Finish Thursday’s 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 $100’s 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 ISP’s

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 AOL’s 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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Tapscott’s “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 Tapscott’s 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

• Sony’s 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 didn’t 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 DVD’s

– 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 doesn’t make it any less important to consider