Strategy
& Technology: A Primer
a gallaugher.com
chapter provided free to faculty & students - just let me know if you use it (john.gallaugher@bc.edu).
©
Copyright 1997-2008, John M. Gallaugher, Ph.D. – for more
info see: http://www.gallaugher.com/chapters.html
last modified: March 14, 2008 (Note: 2007 version of this document is available at: )http://www.gallaugher.com/StratAndTech07.html)
Managers are confused, and for good reason. Management theorists, consultants, and practitioners often vehemently disagree on how firms should craft strategy. Forests of dead trees and barrels of ink have flooded into widely read articles that seem to contradict one another. Headlines such as "Move first or die" compete with "The first mover disadvantage". A leading former CEO advises "destroy your business", while others suggest firms focus on their "core competency" and "return to basics". "IT Doesn't Matter" screams from the pages of the Harvard Business Review, while a NY Times Bestseller hails technology as the "steroids" of modern business.
Theorists proclaiming to have mastered the secrets of strategic management are contentious and confusing. But as a manager, the ability to size up a firm's strategic position and understand its likelihood of sustainability is one of the most valuable, yet difficult skills to master. The business landscape is littered with the corpses of firms killed by managers who guessed wrong. Developing strong skills at strategic thinking is a career long pursuit – a subject that can occupy tomes of text, a roster of courses, and a lifetime of seminars. While this article can't address the breadth of strategic thought it is meant as a first primer on developing the skills for strategic thinking about technology. A manager that understands issues presented in this article should be able to more clearly see through seemingly conflicting assertions about best practice, be better prepared to recognize opportunities and risks, and should be more adept at successfully brainstorming new, tech-centric approaches to markets.
The Danger of Relying on Technology
Firms strive for sustainable competitive advantage, financial performance that consistently outperforms their industry peers. The goal is easy to state, but hard to achieve. The world is so dynamic, with new products and new competitors rising seemingly overnight, that truly sustainable advantage might seem like an impossibility. New competitors and copycat products create a race to cut costs, cut prices, and increase features that may benefit consumers but erode profits industry-wide. Nowhere is this more difficult than when competition involves tech. The fundamental strategic question in the Internet era is 'how can I possibly compete when everyone can copy my technology and the competition is just a click away?' Put that way, it seems like a lost cause.
But there are winners - big, consistent winners – in the world of tech. How do they do it? In order to think about how to achieve sustainable advantage, it's useful to start with two concepts defined by Michael Porter. A professor at the Harvard Business School, and father of the Value Chain and the Five Forces concepts, Porter is rightly considered one of the leading strategic thinkers of the last quarter century.
According to Porter, the reason so many firms suffer aggressive, margin eroding competition, is because they've defined themselves according to operational effectiveness rather than strategic positioning. Operational effectiveness refers to performing the same tasks better than rivals perform them. Everyone wants to be better, but the danger in operational effectiveness is in "sameness". This risk is particularly acute in firms that rely on technology for competitiveness. After all, technology can be easily acquired. Buy the same stuff as your rivals, hire students from the same schools, copy the look and feel of competitor websites, reverse engineer their products, and you can match them. The fast follower problem exists when savvy rivals watch a pioneer's efforts, learn from their successes and missteps, then enter the market quickly with a comparable or superior product at a lower cost before the first mover can dominate.
Since tech can be copied so quickly, followers can be fast, indeed. Several years ago while studying the web portal industry (Yahoo and its competitors), a colleague and I found that when one firm introduced an innovative feature, at least one of its 3 major rivals would match that feature in, on average, only one and a half months. When technology can be matched so quickly, it is rarely a source of competitive advantage. The phenomenon is not limited to the Web. Tech giant EMC saw its stock price appreciate more than any other firm during the decade of the 90s. However when IBM and Hitachi entered the high-end storage market with products comparable to EMC's Symmetrix unit, prices plunged 60% the first year and another 35% the next. Needless to say EMC's stock price took a comparable beating. TiVo is another example. At first blush, it looks like this first mover should be a winner since it seems to have established a leading brand; TiVo is now a verb for all digital recording. But despite this, TiVo is a money loser. Rival digital video recorders offered by cable and satellite companies appear the same to consumers, and are offered along with pay television subscriptions, a distribution channel that TiVo can't control.
Operational effectiveness is critical. Firms must invest in techniques to improve quality, lower cost, and design efficient customer experiences. But for the most part, these efforts can be matched. Because of this, operational effectiveness is usually not sufficient enough to yield sustainable dominance over the competition.
Different is Good
In contrast to operational effectiveness, strategic positioning refers to performing different activities than rivals, or the same activities in a different way. While technology itself is often very easy to replicate, technology is essential to creating and enabling novel approaches to business that are defensibly different than rivals and which can be quite difficult for others to copy.
For an example of the relationship between technology and strategic positioning consider Zara. While unfamiliar in much of the U.S. (where it has less than two dozen stores), Zara is perhaps the world's most successful clothing chain. Zara has helped its parent, the Spanish firm Inditex, grow from obscurity in the mid 90s to the world's second largest pure-play fashion retailer after Gap and ahead of H&M, with financial performance well ahead of these rivals. The firm's founder, Amancio Ortega, is Spain's richest man and the world's wealthiest fashion executive. The fashion director for LVHM has called Zara the "most dangerous retailer in the world".
Although many Zara consumers also shop at Gap, and the brands often have stores located close to each other, Gap has seen profits shrink and debt rise while Zara is minting cash. Zara's success lies in its differences. Gap spends millions on marketing but increasingly finds that when customers arrive in stores they aren't seeing what they want. Same store sales at Gap had fallen in 18 of the past 21 months, prompting a CEO change. When sales continued to fall for two more years, yet another Gap CEO was out of a job. Gap clothes, manufactured mostly by contract firms in Asia or other low-cost labor markets, have to be ordered months in advance. When Gap guesses wrong about trends, the firm is left with huge losses, having to write-off the cost of inventory that no one wants. Customers visit less frequently and the brand is tarnished.
By contrast, Zara asks customers what they want and the firm uses this information to shape its offerings. Managers record customer comments on handheld computers and send trend updates to Zara designers who retool lines based in part on this input. Not only is Zara more accurate in matching offerings with customer desires, the firm can get these new designs into stores far faster than competitors. While rivals outsource to low-cost providers, Zara's parent owns major portions of its manufacturing - even cloth weaving and dye works. For increased speed and coordination, other Zara partners locate close to the firm's Spain-based distribution centers. Supply chain software and robotics take designer plans through cloth cutting and dyeing at amazing speeds. This allows Zara designs to go from concept to store in just two weeks, 12 times faster than Gap. Manufacturing lots are not only more likely to appeal to customers, they are manufactured in smaller runs so that mistakes in trend spotting aren't as costly. The exclusivity of Zara fashions and the fact that new products arrive in stores roughly two times a week gives the firm a loyalty unrivaled in the industry. The average Zara customer visits a remarkable 17 times a year! With customers that loyal, the firm avoids the massive marketing spends of its rivals. It runs no television commercials and typically advertises in newspapers only twice a year. All these savings mean that even with more costly Spain-based manufacturing, Zara still maintains a low-price. The firm's fashions have been described as 'Armani at moderate prices', and "fashions that are Banana Republic with prices that are Old Navy".
Technology is critical to the Zara model, but it's the collective impact of Zara's differences, it's strategic positioning, that delivers success. Rivals can buy handheld computers from the same vendor, but unless they rework their entire way of doing business, they won't surpass Inditex. And while Zara's technology integration is complex and masterful, it is not costly. The firm actually spends less on technology than the industry average, showing that the right investments, when combined with targeted strategic goals, are more important than the size of the investment.
But What Kinds of Differences?
The principles of operational effectiveness and strategic positioning are deceptively simple. But while Porter claims strategy is 'fundamentally about being different', how can you recognize whether your firm's differences are special enough to yield sustainable competitive advantage?
Another set of strategic thinkers say that for a firm to maintain sustainable competitive advantage, it must control a set of exploitable resources that have four critical characteristics. These resources must be 1) valuable, 2) rare, 3) imperfectly imitable (tough to imitate), and 4) non-substitutable. Having all four characteristics is key. Miss value and no one cares what you've got. Without rareness, you don't have something unique. If others can copy what you have, or others can replace it with a substitute, then any seemingly advantageous differences will be undercut.
Strategy isn't just about recognizing opportunity and meeting demand. Resource-based thinking can help you avoid the trap of carelessly entering markets simply because growth is spotted. The telecommunications industry learned this lesson in a very hard and painful way. With the explosion of the Internet it was easy to see that demand to transport web pages, e-mails, MP3s, video, and everything else you can turn into ones and zeros, was skyrocketing. Most of what travels over the Internet is transferred over long haul fiber optic cables, so telecom firms began digging up the ground and laying webs of fiberglass to meet the growing demand. Problems resulted because firms laying long-haul fiber didn't fully appreciate that their rivals and new upstart firms were doing the same thing. On top of that, new technology enabled existing fiber to carry more transmissions than ever before. The end result was overcapacity - these new assets weren't rare and each day they seemed to be less valuable.. For some firms, the transmission prices they charged on newly laid cable collapsed by over 90%. Estimates suggest that the telecommunications industry lost nearly $2 trillion in value in the first part of this decade, much of it due to executives that placed big bets on resources that weren't strategic.
Powerful Resources
Management has no magic bullets. There is no exhaustive list of key resources that firms can look to in order to build a sustainable business. And recognizing a resource doesn't mean a firm will be able to acquire it or exploit it forever. But being aware of major sources of competitive advantage can help managers recognize an organization's opportunities and vulnerabilities, and can help them brainstorm winning strategies.
Imitation-Resistant Value Chains
While many of the resources below are considered in isolation, the strength of any advantage can be far more significant if firms are able to leverage several of these resources in a reinforcing way that makes each stronger and that make the firm's way of doing business more difficult for rivals to match. Firms which craft an imitation-resistant value chain have developed a way of doing business that others will struggle to replicate. The value chain is the set of interrelated activities that bring products or services to market (see sidebar). When we compare Zara's value chain to Gap's, there are differences across every element. But most importantly, the elements in Zara's value chain work together to create and reinforce competitive advantages that others cannot easily copy. The kind of ground-up restructuring to match Zara would require a massive investment for a firm of Gap's size, but with Gap debt downgraded to junk status, so the resources aren't available even if the firm wanted to follow Zara's lead. And despite its recent struggles, the decade-long lead Dell enjoyed in computer sales was similarly difficult for rivals to match. For years Dell's super-efficient manufacturing and direct-to-consumer model combined to help the firm earn seven times more profit on comparably configured PCs than its rivals. It's not that HP, IBM, Sony, and so many others didn't see the advantage of the direct-to-consumer model, it's that these firms were dependent on existing but less efficient retail distribution. Any PC maker trying to quickly move to Dell's direct model risked being dropped by retailers who could easily promote other firms. And those firms that try to match Dell and keep a retail channel also find that they are straddling two markets – a direct-to-consumer market with high margins and a retail market that is far less profitable. During the firm's rise, Dell's sales were nearly all in high margin direct-to-consumer sales and since it didn't have to share a cut of its sale price with retailers, it could start a price war and still have better overall margins that rivals. While competitors were helpless to follow Dell's example, Dell got big and gained additional strategic resources, giving it even more strength over time. While it’s true that nearly two decades of observing Dell has allowed the contract manufacturers serving Dell’s rivals to improve manufacturing efficiency, Dell’s business model remained strong until laptop adoption began to outpace desktop PCs. The direct-to-consumer model suffers in part when consumers want to lift products, type on keyboards, and view screens before making a purchase, so Dell’s market position changed when customer preferences changed.
Brand
A firm's brand is the symbolic embodiment of all the information connected with a product or service, and a strong brand can also be an exceptionally powerful resource for competitive advantage. Want to buy a book online? Auction a product? Search for information? Which firm would you visit first? Almost certainly Amazon, eBay, and Google. But how do you build a strong brand? It's not just about advertising & promotion. First and foremost, customer experience counts. A brand proxies quality and inspires trust, so if consumers can't rely on a firm to deliver as promised, they'll go elsewhere. The upside of this is that if a firm performs well, consumers can often be enlisted to promote a product or service (so called viral marketing). While scores of dot-coms burned through money on Super Bowl ads and other costly promotional efforts, Google, Hotmail, Skype, eBay, MySpace, Facebook and so many other dominant online properties built multi-million member followings before committing any significant spending to advertising. Early customer accolades for a novel service often mean positive press (read free advertising) will also likely follow. But show up late and you may end up paying much more to counter an incumbent's place in the consumer psyche. Amazon spent no money on television advertising in 2005, while Buy.com and Overstock spent millions. MSN's previous year ad spending was 22 times Google's figure. Also, if done well, even complex tech products can establish themselves as killer brands. Consider that Intel has taken an ingredient product that most people don't understand, the microprocessor, and built a quality-conveying name recognized by much of the developed world.
Scale
Many resources are enhanced as a firm grows. Advantages related to a firm's size are referred to as scale benefits. Scale can be a barrier to entry, discouraging new competitors. For example, Intel's size allows the firm to pioneer cutting edge manufacturing techniques and invest $3 billion+ on next generation plants, and although Google was started by two Stanford students in a trailer, the firm today runs on an estimated 450,000 to 1 million servers. The investments being made by Intel and Google would be cost-prohibitive for any startup to match.
Businesses are also sometimes referred to as being scaleable
or having economies of scale. This occurs
when the cost of initial investment can be spread across the production
of many units or in serving multiple customers. Many Internet
businesses are highly scaleable since, as firms grow and serve more
customers with their existing infrastructure, profit margins improve
dramatically. Consider that in just one year, the Internet
firm BlueNile sold as many diamond rings with just 115 employees and
one website as a traditional jewelry retailer would sell through 116
stores. And with lower operating costs, BlueNile can sell at
prices that brick and mortar stores can't match, attracting more
customers and further fueling its scale advantages. Profit
margins improve as the cost to run the firm's single web site and
operate its one warehouse are spread across increasing diamond
sales. Size also gives a firm bargaining power with suppliers
or buyers. As Dell grew large, the firm forced suppliers to locate close to its plants and pushed or
further price concessions. The firm's power increases as it
grows. Similarly, eBay can raise auction fees because of
their market dominance.Sellers who leave eBay lose pricing power since fewer bidders on rival services mean lower prices.
Switching Costs & Data
Switching costs exist when consumers incur an expense to move from one product or service to another. One reason so many people remain with Microsoft's products is that in order to switch to a rival platform, they may have to buy new software, learn a new product, and convert their data. This time and expense is a rock-solid switching cost that (in the words of one Microsoft manager) has enabled the firm to retain customers despite "…all our mistakes, our buggy drivers, our high TCO [total cost of ownership], our lack of a sexy vision at times, and many other difficulties". Similarly, firms that seem dominant but that don't have high switching costs can be rapidly trumped by strong rivals. Netscape once held an 80%+ market share in web browsers, but when Microsoft began bundling Internet Explorer with the Windows operating system and (through an alliance) with America Online, Netscape's market share plummeted. Customers migrated with a mouse click as part of an upgrade or installation. Learning a new browser was a breeze, and with the web's open standards, most customers noticed no difference when visiting their favorite websites with their new browser.
It is critical for challengers to realize that in order to win customers away from a rival, a new entrant must not only demonstrate to consumers that an offering provides more value than the incumbent, they have to that ensure that their value added exceeds the incumbent's value plus any perceived customer switching costs (see Diagram 1). Data can be a particularly strong switching cost for firms leveraging technology. A customer who enters her profile into Facebook, or preferences into NetFlix (DVDs) or FreshDirect (online groceries) may be unwilling to try rivals - even if these firms are cheaper - if moving to the new firm means she'll lose information feeds, recommendations and time savings provided by the firms that already know her well. Fueled by scale over time, firms with more customers and that have been in business longer can gather more data and many can use this data to improve their value chain by offering more accurate demand forecasting or product recommendations.
Diagram 1: In order to win customers from an established incumbent, a late-entering rival must offer a product or service that not only exceeds the value offered by the incumbent, it must exceed the incumbent's value + any customer switching costs.
Differentiation
Commodities are products or services that are nearly identically offered from multiple vendors. Consumers buying commodities are highly price-focused since they have so many similar choices. In order to break the tyranny of the commodity trap, many firms leverage technology to differentiate their goods and services. Dell gained attention from customers, not just due to the low prices, but also because it was one of the first PC vendors to build computers based on customer choice. Want a bigger hard drive? Don't need the fast graphics card? Dell will oblige. Technology has allowed Lands End to take this concept to clothing. Now 40% of the firm's chino and jeans orders are for custom products, and consumers pay a price markup of 1/3 or more for the tailored duds. This kind of tech-led differentiation creates and reinforces other assets. While rivals also offer custom products, Lands' End has established a switching cost with its customers since moving to rivals would require 20 minutes to re-enter measurements and preferences vs. 2 minutes to reorder from landsend.com. The firm's reorder rates are 40-60% on custom clothes, and Lands' End also gains valuable information on more accurate sizing – critical since current clothes sizes provided across the U.S. apparel industry comfortably fit only about 1/3rd of the population.
Data is not only a switching cost, it also plays a critical role in differentiation. Each time a visitor returns to Amazon, the firm uses browsing records, purchase patterns, and product ratings to present a custom home page featuring products that the firm hopes you'll like. Customers value the experience they receive at Amazon so much, that the firm received the highest score ever recorded on the University of Michigan's American Customer Satisfaction Index (ACSI). The score was not just the highest performance of any online firm, it was the highest ranking that any service firm in any industry had ever received.
Capital One has also used data to differentiate its offerings. The firm mines data and runs experiments to create risk models on potential customers. Because of this, the credit card firm was able to aggressively pursue a different set of customers that other lenders considered too risky based on simplistic credit scoring. Finding profitable new markets that others ignored allowed Capital One to grow EPS 20% a year for 7 years, a feat matched by less than 1% of public firms.
Network Effects
AIM has the majority of instant messaging users in the U.S. Microsoft Windows has a 90% market share in operating systems. eBay has an 80% share of online auctions. Why are these firms so dominant? Largely due to the concept of network effects. Network effects (sometimes called network externalities or Metcalfe's Law) exist when a product or service becomes more valuable as more people use it. If you're the first person with an AIM account, then AIM isn't very valuable. But with each additional user, there's one more person to chat with. A firm with a big network of users might also see value added by third parties. Sony's PlayStation 2 was the dominant video game console in part because it had more games than its rivals, and most of these games were provided by firms other than Sony. Third-party add-on products, books, magazines, or even skilled labor are all attracted to networks of the largest number of users, making dominant products more valuable.
Switching costs also play a role in determining the strength of network effects. Tech user investments often go way beyond simply the cost of acquiring a technology. Users spend time learning a product, they buy add-ons, create files, and enter preferences. Because no one wants to be stranded with an abandoned product and lose this additional investment, users may choose a technically inferior product, simply because the product has a larger user base and is perceived as having a greater chance of being offered in the future. The virtuous cycle of network effects doesn't apply to all tech products, and it is strongest when a firm controls a standard (think AIM with their closed system vs. Netscape that used open standards), but in some cases where network effects are significant they can create winners so dominant that firms with these advantages enjoy a near monopoly hold on a market.
Distribution Channels
If no one sees your product, then it won't even get considered by consumers. So distribution channels - the path through which products or services get to customers - can be critical to a firm's success. Sometimes firms benefit from the distribution channels offered by alliance partners. As an example, consider the Sun/Netscape alliance. You've probably visited websites that use the Java programming language on their pages (maybe to play a game, display a chart, or show an advertisement). Your cell phone almost certainly uses Java and your bank probably does, too. Java is a major standard today in part because Netscape included software to run Java in its web browser, in effect using its software as a distribution channel to get Sun's Java on the PCs of millions of users. Even though Netscape eventually failed, today Java thrives and is now so important that the Java runtime (software that enables computers to execute Java programs) comes pre-installed on most PCs, phones, and servers. The initial push to establish the Java standard at a time when Netscape held the majority of the browser market was critical. Without this initial base of Netscape users to jumpstart demand, most programmers would never have written Java code.
While Netscape received little from its distribution alliance with Sun, distribution through tech products can be very lucrative for product and service owners. Google receives over 40% of its ad revenue not from search ads, but from advertisements run on third party sites ranging from lowly blogs to the New York Times. In another move by Google to get its ads served from more places, the firm will pay Dell an estimated $1 billion for the privilege of pre-installing the Google Toolbar and Google Desktop Search software on all PCs Dell sells. The price tag for access to Dell desktop real estate may seem excessive, but Google feels it needs to secure channels for its search since Microsoft can bundle its own search as the default in the Windows Vista operating system, on Internet Explorer, within MSN, and through its other offerings. Sometimes product-based distribution channels can provide firms with such an edge, that international regulators have stepped in to try to provide a more level playing field. Microsoft was forced by European regulators to unbundled the Windows Media Player, for fear that it provided the firm with too great an advantage when competing with the likes of RealPlayer and Apple's QuickTime.
Users can also be recruited to create new distribution channels. You may have visited websites that promote books sold on Amazon.com. Website operators do this because Amazon gives them a cut of all purchases that come in through these links. Amazon now has over 1 million affiliates (which the firm calls associates), yet it only pays them if a promotion gains a sale.
What about patents?
In the United States, technology and (more controversially) even business models can be patented. Firms that receive patents have some degree of protection from copycats that try to identically mimic their products and methods. But even if an innovation is patentable, that doesn't mean that a firm has bulletproof protection. Some patents have been nullified by the courts upon later review (usually because of a successful challenge to the uniqueness of the innovation). Software patents are also widely granted, but notoriously difficult to defend. In many cases, coders at competing firms can write substitute algorithms that aren't the same, but accomplish similar tasks. For example, although Google's PageRank algorithms are fast and efficient, Microsoft, Ask, and Yahoo now offer their own, non-infringing search that presents results with an accuracy that many would consider on par with PageRank. Patents do protect operations innovations at firms like NetFlix and Harrah's, and design innovations like the iPod click wheel. But in a study of the factors that were critical in enabling firms to profit from their innovations, Carnegie Mellon professor Wes Cohen found that patents were only the fifth most important factor. Secrecy, lead time, sales skills, and manufacturing all ranked higher.
Barriers to Entry, Technology, and Timing
Some have correctly argued that the barriers to entry for many tech-centric businesses are low. This is particularly true for the Internet when rivals can put up a competing website seemingly overnight. But market entry is not the same as building a sustainable business, and just showing up doesn't guarantee survival. iWon.com entered the portal market with amazing speed. The founders went from discussing the idea over cheeseburgers to launching a Yahoo look-alike in less than 9 months. Entry barriers were low because so much of the technology and services that the firm needed to acquire were available through third parties. Consulting firm Sapient built the website, Inktomi (which at the time also handled search for Yahoo) provided search, and DoubleClick handled ad sales. The firm's partnership with CBS (an early investor) allowed iWon to showcase giveaways in a television program that reached a national prime time audience. But even with its rapid entry and heavy media exposure, latecomer iWon never came close to challenging Yahoo's brand power. If barriers to entry appear to be low, rivals may initially flood the market. However, as the difficulty in competing with incumbents becomes apparent, the intensity of competition from new entrants will taper off.
Platitudes like "follow, don't lead", can put firms dangerously at risk, and statements about low entry barriers ignore the difficulty many firms will have in matching the competitive advantages of successful tech pioneers. Should Blockbuster have waited while Netflix pioneered? In a year where Netflix profits were up seven fold, Blockbuster lost more than $1 billion. Should Sotheby's have dismissed seemingly inferior eBay? Sotheby earned $69 million in profit in 2005, eBay earned $1.3 billion. Barnes & Nobel waited 17 months to respond to Amazon.com. Today Amazon has over 3 times the profits of its offline rival and its market cap is 16 times greater. Today's Net giants are winners because in most cases they were the first to move with a profitable model and they were able to quickly establish resources for competitive advantage. With few exceptions, established off-line firms have failed to catch up to today's Internet leaders.
Timing and technology alone will not yield sustainable competitive advantage. Yet both of these can be enablers for competitive advantage. Put simply, it's not the time lead or the technology, it's what a firm does with its time lead and technology. True strategic positioning means that a firm has created differences that cannot be easily matched by rivals. Moving first pays off when the time lead is used to create critical resources that are valuable, rare, tough to imitate, and lack substitutes. Anything less risks the arms race of operational effectiveness. Build resources like brand, scale, network effects, switching costs, or other key assets and your firm may have a shot. But guess wrong about the market or screw up execution and failure or direct competition awaits. It is true that most tech can be copied – there's little magic on eBay's servers, Intel's processors, Oracle's databases or Microsoft's operating systems that past rivals have not at one point improved upon. But the lead that each of these tech-enabled firms had was leveraged to create network effects, switching costs, data assets, and helped build solid and well respected brands.
• • •
Sidebar: The Five Forces of Industry Competitive Advantage
Professor and strategy consultant Gary Hamel wrote in a Fortune cover story that "The dirty little secret of the strategy industry is that it doesn't have any theory of strategy creation". While there is no silver bullet for strategy creation, strategic frameworks help managers describe the competitive environment a firm is facing. Frameworks can also be used as a brainstorming tool to generate new ideas for responding to industry competition. If you have a model for thinking about competition, it's easier to understand what's happening and to think creatively about possible solutions.
One of the most popular frameworks for examining a firm's competitive environment is Porter's Five Forces, also known as the Industry and Competitive Analysis. As Porter puts it, "analyzing [these] forces illuminates an industry's fundamental attractiveness, exposes the underlying drivers of average industry profitability, and provides insight into how profitability will evolve in the future". The five forces the framework considers are 1) the intensity of rivalry among existing competitors, 2) the threat of new entrants, 3) the threat of substitute goods or services, 4) the bargaining power of buyers, and 5) the bargaining power of suppliers (see Diagram 2).
Diagram 2: The Five Forces of Industry Competitive Analysis
New technologies can create jarring shocks in an industry. Consider how the rise of the Internet has impacted the five forces for music retailers. Traditional music retailers like Tower and Virgin find that customers are seeking music online and scramble to invest in the new channel out of what is perceived to be a necessity. Their intensity of rivalry increases because they not only compete based on the geography of where brick-and-mortar stores are physically located, they now compete online as well. Investments online are expensive and uncertain, prompting some firms to partner with new entrants such as Amazon. Free from brick-and-mortar stores, Amazon, the dominant new entrant has a highly scaleable cost structure. And in many ways the online buying experience is superior to what customers saw in stores. Customers can hear samples of almost all tracks, selection is seemingly limitless (the "long tail" phenomenon), and data is leveraged using collaborative filtering software to make product recommendations and assist in music discovery. Tough competition, but it gets worse because CD sales aren't the only way to consume music. The process of buying a plastic disc now faces substitutes as digital music files become available on commercial music sites. Who needs a CD filled with ones and zeros when you can buy the bits one song at a time? Or don't buy anything, subscribe to a limitless library. From a sound quality perspective, the substitute good of digital tracks purchased online is almost always inferior to their CD counterparts. To transfer songs quickly and hold more songs on an MP3 player, tracks are encoded in a smaller file size than what you'd get on a CD, and this smaller file contains lower playback fidelity. But the additional tech-based market shock brought on by MP3 players (particularly the iPod) has changed listening habits. The convenience of carrying thousands of songs trumps what most consider just a slight quality degradation. iTune's is now responsible for selling more music online or off than any other firm, save retail giants Wal-Mart and Best Buy. Most alarming to the industry is the other widely adopted substitute for CD purchases – theft. Music is available illegally, but free. And while exact figures on real losses from online piracy are in dispute, the music industry has seen sales drop by over 1/3 since 2000. All this choice gives consumers (buyers) bargaining power. They demand cheaper prices and greater convenience. The bargaining power of suppliers – the music labels – also increases. At the start of the Internet revolution, retailers could pressure labels to limit sales through competing channels. Now, with many of the major music retail chains in bankruptcy, labels have a freer hand to experiment.
While it can be useful to look at changes in one industry as a model for potential change in another, it's important to realize that the changes that impact one industry do not necessarily impact other industries in the same way. For example, it is often suggested that the Internet increases bargaining power of buyers and lowers the bargaining power of suppliers. This is true for some industries like auto sales and jewelry where the products are commodities and the price transparency of the Net counteracts a previous information asymmetry where customers often didn't know enough information about a product to bargain effectively. But it's not true across the board. In cases where network effects are strong or a seller's goods are highly differentiated, the Internet can strengthen supplier bargaining power. The customer base of an antique dealer used to be limited by how many likely purchasers lived within driving distance of a store. Now with eBay, the dealer can take a rare good to a global audience and have a much larger customer base bid up the price. Switching costs also weaken buyer bargaining power. Wells Fargo has found that customers who use online bill pay (where switching costs are high) are 70% less likely to leave the bank than those who don't, suggesting that these switching costs help cement customers to Wells even when rivals offer more compelling rates or services.
Tech plays a significant role in shaping and reshaping these five forces, but it's not the only significant force that can create an industry shock. Government deregulation or intervention, political shock, and social and demographic changes can all play a role in altering the competitive landscape. Because we live in an age of constant and relentless change, mangers need to continually visit strategic frameworks to consider any market impacting shifts. Predicting the future is difficult, but ignoring change can be catastrophic.
• • •
The value chain is the "set of activities through which a product or service is created and delivered to customers" (Porter 2001). By examining the activities in a firm's value chain, managers are able to gain a greater understanding of how these factors influence a firm's cost structure and value delivery. There are five primary components of the value chain and four supporting components.
The primary components are:
· Inbound logistics – getting needed materials and other inputs into the firm from suppliers
· Operations – turning inputs into products or services
· Outbound logistics – delivering products or services to consumers, distribution centers, retailers, or other partners
· Marketing and Sales – customer engagement, pricing, promotion, transaction
· Support – service, maintenance, and customer support
The secondary components are:
· Firm infrastructure – functions that support the whole firm, including general management, planning, IS, and finance
· Human resource management – recruiting, hiring, training, and development
· Technology / Research & Development – new product and process design
· Procurement – sourcing and purchasing functions
While the value chain is typically depicted as it's displayed in Diagram 3, goods and information doesn't necessarily flow in a line from one function to another. For example, an order taken by the marketing function can trigger an inbound logistics functions to get components from a supplier, operations functions (to build a product if it's not available), and/or outbound logistics functions (to ship a product when it's available). Similarly, information from service support can be fed back to advise R&D in the design of future products.
Diagram 3: The Value Chain
An analysis of a firm's value chain can reveal operational weaknesses, and technology is often of great benefit to improving the speed and quality of execution. Software tools such as supply chain management (SCM: linking inbound and outbound logistics with operations), customer relationship management (CRM: supporting sales, marketing, and in some cases R&D), and enterprise resource planning software (ERP: software implemented in modules to automate the entire value chain), can have a big impact on more efficiently integrating the activities within the firm, as well as with its suppliers and customers. But remember, these software tools can be purchased by all competitors. Although they can cut cost and increase efficiency, if others can buy the same or comparable products then these technologies, while valuable, may not yield lasting competitive advantage. Even more important to consider, if a firm adopts software that changes a unique process into a generic one, it may have co-opted a key source of competitive advantage. SCM, CRM, and ERP software typically require adopting a very specific way of doing things. Dell stopped deployment of the logistics and manufacturing modules of its ERP implementation when it realized that the software would require the firm to make changes to its unique and highly successful operating model. By contrast, Apple had no problem adopting ERP because the firm competes on product uniqueness rather than operational differences.
From a strategic perspective, managers can also consider the firm's differences and distinctiveness compared to rivals. If a firm's value chain cannot be copied by competitors without engaging in painful tradeoffs, or if the firm's value chain helps to create and strengthen other strategic assets over time, it can be a key source for competitive advantage. Many of the examples given in this paper, including FreshDirect, Zara, Amazon, and eBay, illustrate this point.
• • •
About the Author:
John
Gallaugher is a member of the Dept. of Information Systems in Boston
College's Carroll School of Management. Prof. Gallaugher
teaches courses and conducts research at the intersection of technology
and strategy. He leads the school's TechTrek programs,
co-leads the Asian field study program, and has consulted to several
organizations including Accenture, Alcoa, Brattle Group, ING Group,
Staples, State Street, the U.S. Information Agency. Writings,
podcasts, course material, and research by Prof. Gallaugher
can be found online at www.gallaugher.com.
• • •
References
Bezos, Jeff, "Letter to Shareholders", Amazon.com Investor Relations, 2002. http://library.corporate-ir.net/library/97/976/97664/items/72959/2002_shareholderLetter.pdf.
Boorstin, Julia, "Fashion Victim", Fortune, April 13, 2006.
Boulding, William; Christen, Markus, "First-Mover Disadvantage", Harvard Business Review, Vol. 79, No. 9, October 2001, pp. 20-21.
Breen, Bill, "Living in Dell Time", Fast Company, November 2004.
Carr, Nicholas, "IT Doesn't Matter", Harvard Business Review, Vol. 81 Issue 5, May 2003, pp. 41-49.
Connolly, Marge M., CIO and VP of Operations, CapitalOne, Senior Executive Lecture Series, Boston College, Oct. 31, 2001.
Davenport, Thomas, "Putting the Enterprise Into the Enterprise System", Harvard Business Review, Vol. 76, No. 4, pp. 121-132.
The Economist (Online Edition), "The Future of Fast Fashion", June 18, 2005.
Forbes Online, "TiVo Sales Remain Tepid Despite Fanatic Fans", Sept. 11, 2003.
Friedman, Thomas, The World Is Flat: A Brief History of the Twenty-first Century, Farrar, Straus and Giroux, New York, NY, 2005.
Gallaugher, John, "E-Commerce and the Undulating Distribution Channel”, Communications of the Association for Computing Machinery (CACM) , Vol. 45, No. 7. July 2002, pp. 89-95.
Gallaugher, John, and Downing, Charles, "Portal Combat: An Empirical Study of Competition in the Web Portal Industry", Journal of Information Technology Management. Vol. 11, No. 1-2, 2000, pp. 13-24.
Gunther, Marc and Gashurov, Irene, "Eyes On The Prize An upstart Internet portal grabs market share with a shockingly simple idea: running a sweepstakes", Fortune, October 16, 2000
Hamel, Gary, "Killer Strategies that Make Shareholders Rich", Fortune, Cover Story, June 23, 1997.
Kahney, Leander, "Net Speed Ain't Seen Nothin' Yet", Wired News, March 21, 2000.
Marson, Ingrid, "Microsoft vs EC: The story so far", ZDNet UK, April 24, 2006.
McGregor, Jenna, "High Tech Achiever", Fast Company, Oct. 1995, pp. 48-51.
Mata, F. J., W. L. Fuerst, and J. B. Barney (1995) "Information technology and sustained competitive advantage: a resource-based analysis", MIS Quarterly, Vol. 19, No. 4, pp. 487-505.
Mullaney, Timothy, "Jewelry Heist", BusinessWeek, May 10, 2004.
Mullaney, Timothy and Ante, Spencer, "InfoWars", BusinessWeek, June 5, 2000.
Pocaisk, Stephen, A Failure to Communicate: Reforming Public Policy in the Telecommunications Industry, Economic Policy Institute, Washington, DC, 2004.
Pontin, Jason, "Second-Mover advantage", Technology Review, Vol. 108 Issue 5, May 2005, p. 12.
Porter, Michael, Competitive Advantage: Creating and Sustaining Superior Performance, New York, NY, The Free Press, 1985.
Porter, Michael, "Strategy and the Internet", Harvard Business Review; Vol. 79 No. 3, March 2001, p62-78.
Porter, Michael, "What is Strategy?" Harvard Business Review, Vol. 74, No. 6, Nov-Dec., 1996, pp. 61-78.
Reingold, Jennifer, "What We Learned in the New Economy", Fast Company, Issue 80, March 2004, pp. 56.
Schlosser, Julie, "Cashing in on the new world of me", Fortune, Dec. 1, 2004.
Suarez, Fernando; Lanzolla, Gianvito, "The Half-Truth of First-Mover Advantage", Harvard Business Review, Vol. 83, No. 4, April 2005, p121-127.
Surowiecki, James, "The Most Devastating Retailer in the World", The New Yorker, September 18, 2000, p. 74.