Profits and the Internet: Seven Misconceptions

Most managers rightly see profitable growth as essential to their business. However, given the realities of competition and the irreducible uncertainty in business, there will always be a gulf between the pursuit of profitable growth and its achievement. When the Internet arrived, many believed the gulf would narrow. Unfortunately, the opposite has been true.

To be sure, the Internet is powerful. It is opening the way to new markets, customers, products and modes of conducting business. But it also is prompting newcomers and veterans alike unwittingly to embrace some dangerous half-truths and to neglect serious tensions beneath seemingly sensible strategy choices. The consequences are visible in the long list of failed dot-coms. At established companies, the effects might be muted, but if the past is any indicator, they too are susceptible to the penalties of inadequate strategy scrutiny.

In assessing Internet-related business opportunities, companies must not let what is technologically feasible overshadow what is strategically desirable. To minimize any unintentional destruction of value, they must think through the full implications of the strategy choices they are making. In particular, they must be alert to seven widely held misconceptions.

The “First-Mover Advantage” Misconception

A land-grab mentality has pervaded the Internet, not just in startups such as Bluefly, ChateauOnline and QXL.com, but also in established companies such as Microsoft, Telefonica and Reuters. The logic is that one driver of success (if not the key driver) in Internet-related business is being first. That view has merit. Being first can give a company a frontier-pushing aura (as it did for Apple Computer); can generate free publicity and valuable brand recognition (Amazon.com and Yahoo! Inc.); can move companies down proprietary learning curves (Intel); and can provide a bigger opportunity to lock in unattached customers and achieve critical mass (America Online).1

Yet, in Internet business, first-mover status is a precarious perch on which to rest strategy, and managers should not overrate the importance of early entry and the durability of the advantages it might bring. To see why, consider three strains of first-mover advantage.

The Limits of Preemption

The strategic strain of first-mover advantage rests on preemption — the premise that “the early bird gets the worm.” It applies, for example, to airlines’ choices of routes and oil refiners’ capacity decisions. However, preemption works only when two conditions are satisfied.2 First, the opportunity under consideration must be efficiently sized.

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References

1. For a review of several theoretical and empirical studies on this topic, see F.M. Scherer and D. Ross, “Industrial Market Structure and Economic Performance” (Boston: Houghton Mifflin, 1990), 407, 586–589.

2. M.E. Porter, “Competitive Strategy” (New York: Free Press, 1980), 336–338.

3. M.B. Lieberman and D.B. Montgomery, “First-Mover Advantages,” Strategic Management Journal 9 (September 1988): 41–58; and I. Dierickx and K. Cool, “Asset Stock Accumulation and Sustainability of Competitive Advantage,” Management Science 35 (December 1989): 1504–1511.

4. C. Shapiro and H.R. Varian, “Information Rules” (Boston: Harvard Business School Press, 1998), chapter 7. We have seen no consensus on the distinction between Old and New Economy companies. One way to contrast the two might be to categorize New Economy companies as those operating businesses in which standards tend to matter, product life cycles are relatively short, and network externalities generally hold.

5. G. Saloner, A. Shepard and J. Podolny, “Strategic Management” (New York: John Wiley, 2001), chapter 9.

6. M. Cusumano, Y. Mylonadis and R. Rosenbloom, “Strategic Maneuvering and Mass-Market Dynamics: The Triumph of VHS Over Beta,” Business History Review 66 (spring 1992): 51–94.

7. P. Evans and T.S. Wurster, “Getting Real About Virtual Commerce,” Harvard Business Review 77 (November–December 1999): 85–94.

8. For a full discussion of the concept of fit, see M.E. Porter, “What Is Strategy?” Harvard Business Review 74 (November–December 1996): 61–78; and N. Siggelkow, “Change in the Presence of Fit: The Rise, the Fall and the Renascence of Liz Claiborne,” Academy of Management Journal 44 (August 2001).

9. G.A. Moore, “Living on the Fault Line” (New York: HarperCollins, 2000), chapter 1.

10. For a discussion of competitive leverage (using rivals’ strengths to advantage), see M. Cusumano and D. Yoffie, “Competing on Internet Time” (New York: Free Press, 1998). For a discussion of internal leverage (leveraging core competencies), see G. Hamel and C.K. Prahalad, “Competing for the Future” (Boston: Harvard Business School Press, 1994).

11. For a discussion on the importance of governance in Internet-related business, see N. Venkatraman, “Five Steps to a Dot-Com Strategy: How To Find Your Footing on the Web,” Sloan Management Review 39 (spring 2000): 15–28.

12. O.E. Williamson, “Markets and Hierarchies” (New York: Free Press, 1975), chapter 2.

13. For a discussion of when and how alliance arrangements can play a role in organizing for innovation, see H.W. Chesbrough and D.J. Teece, “When Is Virtual Virtuous?” Harvard Business Review 74 (January–February 1996): 65–73; and Y. Doz and G. Hamel, “Alliance Advantage” (Boston: Harvard Business School Press, 1998).

14. C. Kim and R. Mauborgne, “Fair Process: Managing in the Knowledge Economy,” Harvard Business Review 75 (July–August 1997): 65–75.

15. For a discussion of how companies might deal with this growing challenge, see A. Gawer and M. Cusumano, “Platform Leadership: How Market Leaders Drive Industry Innovation” (Boston: Harvard Business School Press, spring 2002).

16. D. Champion and N.G. Carr, “Starting Up in High Gear: An Interview with Venture Capitalist Vinod Khosla,” Harvard Business Review 78 (July–August 2000): 99.

17. Moore, “Living on the Fault Line,” 20.

18. For perspectives on how companies can create customer value and sustain competitive advantage, see C. Kim and R. Mauborgne, “Value Innovation,” Harvard Business Review 75 (January–February 1997): 103–112; and Porter, “What Is Strategy?”

ADDITIONAL RESOURCES

In recent years, many works have focused on the Internet and its impact on business strategy. Among them, a 2000 McGraw-Hill book, “Net Ready,” by Amir Hartman, John Sifonis and John Kador, offers managers a big-picture view of the possibilities associated with the Internet. It makes the applications concrete by describing the practice at Cisco Systems, where Hartman and Sifonis are executives. “

Finding Sustainable Profitability in Electronic Commerce,” by J.M. de Figueiredo, from the summer 2000 issue of MIT Sloan Management Review, provides an insightful discussion on when and how companies can orient e-commerce strategies for competitive advantage. “

Internet Business Models and Strategies,” by Allan Afuah and Christopher Tucci, published this year by McGraw-Hill, attempts to link Internet technology, business models, the competitive landscape and company performance.

A 2001 Strategic Management Journal article, “Value Creation in e-Business,” by R. Amit and C. Zott, examines the sources of value creation in the business models of 59 U.S. and European businesses. The article explores the business model as a locus of innovation.

Acknowledgments

We thank Lourdes Casanova, Ingemar Dierickx, Soumitra Dutta, Paolo Fulghieri, Javier Gimeno, Randal Heeb, Goncalo Pacheo de Almeida, Werner Reinartz, Jeff Reuer, Timothy Van Zandt and the reviewers for their helpful comments. We especially thank Dominique Heau, and, for support of this work, eLab@INSEAD.