Strategy in the Internet Age
Site maintained & copyrighted by John Gallaugher.  Many examples & concepts are referred to in my lectures and research.  Inquiries regarding working papers are welcome.

Note: folks at my executive lectures have asked me for recommended readings.  During the lecture I mentioned Clayton Christensen's "The Innovator's Dilemma" (Harvard Business School Press, 1997).  Other recommended books are mentioned in my FAQ.  Most of my research is more academic than practitioner oriented, but you may enjoy a recent piece I wrote on "Internet Commerce Strategies: Challenging the New Conventional Wisdom" that appeared in the July 1999 issue of Communications of the ACM.

Disintermediation

  • Book Sales

    • Amazon.com has built three warehouses in order to eliminate Ingram & other book wholesalers.  Eliminating the middleman should reduce Amazon's cost of goods and increase their average shipping time for bestsellers (they only stock a fraction of books they sell).  However, this type of disintermediation (economies of scale-based) has been occurring long before the advent of web commerce.
  • Publishing

    • For over 170 years, cargo shippers have paid to have their shipping listings in the Journal of Commerce.  Now shippers such as P&O Nedlloyd are posting their listings on the web.  The Journal of Commerce has seen ad revenues decline 14% during 1997 and laid off 65 of 450 employees in early 1998 (see article).  Disintermediation could occur because the digital equivalent added more value (more accurate schedule information, online reservations) than the intermediary's equivalent.  The Journal's alternative?  Develop a better web-site & become a new intermediary.
  • Travel

    • Online travel agents have entered from unexpected areas.  Expedia is owned by Microsoft, Travelocity is owned by AMR - the holding company for American Airlines, and Preview was formerly a media production company (the later two recently merged).  However, the viability of this industry is in doubt as low-margin airlines seeking lower operating costs are squeezing the margins of travel agents, lowering commissions to only $10/ticket for domestic online flights.
  • Failed Efforts

    • Value Gaps - the removing an intermediary without recognizing the value added - was at the heart of the failures below:
    The WebSaver annuity disintermediated middlemen who were vital to the process of selling and educating consumers regarding annuity products.  Despite positive press and well positioned online advertising, the product flopped.  Lesson – don't disintermediate essential elements of the distribution chain.
    FlowerNet, sponsored by Miami-based Sunburst Farms, attempted to disintermediate flower shops by using FedEx as a delivery mechanism.  The firm originally sold flowers at great savings, but neglected to invest in brand building to create a perception of trust, quality, and awareness.  Lesson - disintermediation may require the disintermediator to take up the promotional functions which middlemen had previously provided.
    Internal Disintermediation
  • Financial Services

    • While organizations aren't being removed from the distribution chain as readily as originally predicted, employees who add little or negative value are in jeopardy of internal disintermediation - being replaced by a computer interface. E*Trade’s original slogan, “Boot Your Broker”, flaunted the cost advantages of eliminating the broker as middleman.  Fidelity charges $138.95 to trade 1,000 NASDAQ shares with a human broker, but from $14.95-$19.95 to perform the identical trade online.  This two-tier brokerage service is an example of internal disintermediation (Fidelity's service bypasses their own brokers).  Automatic Teller Machines (ATMs) are another good example of internal disintermediation.
    Marketplace (atoms) to Marketspace (bits)
  • Software

    • Egghead software experienced steady declines in revenue due to shifts from mall stores to superstores & catalogs.  As a result, the firm shuttered all 80 stores in early 1998 & re-christened itself Egghead.com.  The exit move from physical to virtual-only storefront seems appears to be a successful strategy, with current US laws offering an elimination of sales taxes as well.  The firm runs three web sites including a Surplus Auction.
  • Banking

    • BankOne is offering Wingspanbank.com as a pre-emptive cannibalization move.  Compare Wingspan to BankOne on checking rates (4.5% vs. 1%), mutual funds (7,000 vs. 48), bill payment fees (free vs. $4.95), and the fact that Wingspan will offer mortgages from 60 companies and insurance from 15 carriers. Wingspan will be a portal that leverages the bank's ATM network but forbids access to 1,900 branches.  Why eat your own?  In the first 6 months of 1999, 35 insurance companies, BMW, Nordstrom, Ford, and Wal-Mart have all filed for bank charters.  Citibakn will be offering ATMs through Blockbuster & Kinkos.  The landscape is changing - leverage your existing assets (customers & ATM network in BankOne's case) or die.
  • Channel Conflicts

    • Retailer Williams-Sonoma makes it clear that the firm's 279 stores & print catalog will not carry products sold over the web.  They can accomplish this as a strong retail brand that is vital for weaker suppliers needing distribution. On the other end of the channel, manufacturer Levis prohibits web-retailers from carrying Levis products, however it does sell list-priced goods at Levis.com.  Unstated may be Levis attempts to maintain profit margin among retailers who would otherwise certainly be undercut by web merchants.  Compaq recently was forced to halt sales to web-only retailers, a sign that low prices & high-inventory turnover from Net-based vendors is adversely impacting Compaq's traditional brick and mortar retail channel.  Sony, a firm feeling pressure from its own music unit and from music retailers, was beat to the MP3 market by Diamond Multimdia, maker of the Rio digital music player, a product that sold 200,000 units in its first 10 months.
    New Intermediaries
  • Successes

    • Firms like Auto-By-Tel and Schwab (through the OneSource funds network) have extended the distribution chain for autos and mutual funds respectively by identifying opportunities to add digital value.  Such efforts may lower search costs and switching costs and increase satisfaction for consumers while exerting price pressure on suppliers.  Supplying firms de-emphasize profit margin & focus on volume (margin is traded for volume - the product or service provided moves further toward commodity).  Suppliers also lose their valuable point-of-contact with the customer.  As the front-line interface with the consumer, the new intermediary must invest in advertising and brand building.
  • Threats

    • New intermediaries may see competition from powerful suppliers that integrate forward.  General Motors has rolled out an Auto-By-Tel equivalent in GMBuyPower, while Fidelity launched its own funds network shortly after Schwab's proved a success.  Competitors who secure or create key distribution channels may also have an advantage.  Firms with strong distribution channels may also pose a threat to new comers.  Microsoft's CarPoint can compete with Auto-By-Tel through leveraging Microsoft’s many distribution channels (WebTV, Microsoft Network, Internet Explorer channels).
    Network Externalities
  • Metcalfe's Law

    • Metcalfe's Law, also known as network externalities, states that a product or service becomes more valuable as its installed base of users expands.  Such product and services include market mechanisms that require critical mass to fuel near monopolistic success, but can fail if that mass is never achieved. This principle is behind recent moves by Fairmarket to group together roughly 100 auction sites in a challenge to eBay's proprietary network.
  • ECNs and other New Trading Mechanisms

    • Electronic Communications Networks bypass the traditional market makers, linking up buyers with sellers.  Firms such as Island, Archipelago, and MarketXT have grown to control 20% of NASDAQ volume in key securities. However eight of ten trades can't match market maker prices due to a lack of buyers and sellers. After-hours trading by many firms has been largely a bust for the same reason - not enough bidders.  Optimark, a non-ECN, allows institutions to mask their purchasing intentions and uses fuzzy-logic to set up orders.  The system went live with NADAQ stocks on Oct. 11th.  W.R. Hambrecht offers anyone with a minimum $2,000 account access to IPOs that it offers.  Despite the compelling nature of the offer, the effort may still suffer from value-gap issues such as a lack of research.  It is trying to get around limited liquidity by partnering with Fidelity's discount brokerage arm.
    Leveraging Strategic Assets
  • Strengthen Brands

    • Brands inspire trust, communicate quality, and lower search costs.  Early movers have an advantage in brand building.  Consider Yahoo, a firm that has built one of America's top 25 brands in less than 4 years.  My research shows that Yahoo's sole advantage is its brand - technology has no sustainable impact on wooing users.  Consulting / research firms Nua, Netcraft, and Network Wizards regularly appear in the trade press by offering surveys compiled at a low cost.  But second-stage brand building is costly – during Q4 1997, the average discount brokerage spent 4-7% of revenues on advertising, while Internet brokerages spent 15-20%.
  • Create Economies of Scale

    • Size still matters for atoms-based businesses.  In late 1997, Amazon.com scrambled to open large warehouses on each US coast.  Barnes & Noble’s warehouses allow it to buy directly from publishers (disintermediating the book distributors which Amazon uses).  A large stock also allows B&N to deliver product quickly, increasing its service levels.  B&N's brick & mortar stores give it scale, but also subject it to sales tax on Internet deliveries shipped to states where the firm has stores.
    But online discount brokers are proving size also maters for bits-based businesses.  E*Trade leverages the scale of its customer base to offer small investors IPO access through BancBoston Robertson, Stephens.  Fidelity has a similar arrangement with Salomon Smith Barney, while Schwab has teamed with three Wall St. underwriters (Hambrecht & Quist, CS First Boston, and JP Morgan).  This scale benefit allows these firms to differentiate and add a service that small newcomers can't match.
  • Differentiate Commodity Offerings

    • Dell, Gateway, CD-Now's superSonicBOOM, and Cisco allow consumers to purchase custom-configured products, with product configuration handled by the customer over the Internet.  This allows these firms to differentiate products that might otherwise be deemed as commodity products.
  • But Beware Reliance on Technology Alone

    • EddieBauer (virtual dressing room), HomePortfolio (home remodeling), LandsEnd (virtual model & Oxford Express), and Clairol (hair color/style selector) offer services that complement their product lines.  But beware, Internet technologies allow firms to quickly deploy (and respond to) competitive threats (note similarities between Eddie Bauer & LandsEnd).  Information technology alone can not provide a lasting source of competitive advantage.
  • Switching Costs

    • Firms can create switching costs through frequent buyer programs (like the Yahoo Visa Card). Customer databases that are built over time are also difficult to replicate (e.g. Firefly, NetPerceptions, and Reel.com's ReelGenius). Be aware that many large firms (e.g. Blockbuster) already have databases which may be used for market segmentation, targeting, and collaborative filtering.  Virtual communities that yield value (e.g. ParentsPlace, Ragingbull.com, the Plastics Network) are difficult to leave when a user has invested in developing relationships with those who remain.  However, regulations have prevented firms like Fidelity from offering discussion groups & other types of customer interaction.
  • Create / Dominate & Leverage Distribution Channels

    • CD-Now and Amazon.com paid upwards of $5.5 million each for exclusive deals with Yahoo (type “Madonna” into Yahoo & see what ads appear).  America Online and other search engines are inking similar deals.  Microsoft dominates several channels with WebTV, Internet Explorer Channels, and the Microsoft Network.  Compaq has begun building special keys on it's keyboards that it can sell links to for a profit.  Dell has begun to leverage the fact that it accounts for 1/2 of all Net-based PC sales by opening Gigabuys.com to sell over 30,000 products online.. Alexa has created a task bar that offers content rating & navigation benefits. The Pixel Company has even created their own distribution channel by offering free software that covertly extends the visible area on your computer screen by 25 pixels.  This extra area on your screen can be used as an organizing utility, with additional links sold to other firms at a price (a kind of virtual real-estate).  And in the world of music, Motorola (the firm that developed the first car radio) has launched RadioWave.com, a site that allows you to listen to broadcast stations around the country, view album covers while listening, and order albums (currently through Amazon.com).  The new distribution channel will bring in advertising & e-commerce revenue, but stronger brands may try to match them. Rolling Stone Radio. Pointcast & Broadcast.com are other examples of emerging Internet media networks.  Free-PC.com is even giving away PCs in hopes of creating a targeted advertising distribution channel.
  • Leverage Alliances or Partnerships

    • By offering to share revenue with linking partners, firms like Amazon.com and Barnes & Nobel are broadening their reach.  These affiliate or associate programs (revenue sharing agreements for those willing to link to an e-commerce site) can boost brand awareness, traffic, and sales.  Amazon has over 60,000 affiliates (which Amazon calls associates) worldwide.  Travelocity has partnered with Comdex, offering a one-click search for flights that only go to the Comdex host city.  Blockbuster & Prodigy have partnered to offer a customized version of myBlockbuster (note that this creates preference database switchign costs) & distribute Prodigy CDs at Blockbuster outlets.  Citibank has allied with Blockbuster and Kinkos to offer Citibank ATMs in these stores.
     © John Gallaugher, 1994-1999.
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    Last modified Oct. 29, 1999