Business Models and Successful Strategy

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TABLE OF CONTENTS Introduction to Internet Strategy Business Models and Successful Strategy
Five steps to a dot.com strategy: How to find your footing on the Web; Sloan Management Review; N Venkatraman; Spring 2000; 14 Making business sense of the e-opportunity; Sloan Management Review; David Feeny; Winter 2001; 11 Playing the e-commerce game; Business and Economic Review; Varun Grover; OctDec 2000; 6 Business models for Internet-based E-commerce: An anatomy; California Management Review; B Mahadevan; Summer 2000; 15 Hybrid retail: Integrating e-commerce and physical stores; Industrial Management ; Reuven Levary; Sep/Oct 2000; 8 A lesson in strategy: Case study 1; Hospitals & Health Networks ; Lee Ann Runy; Dec 2000; 4
Five steps to a dot.com strategy: How to find your footing on the Web
Sloan Management Review; Cambridge; Spring 2000; N Venkatraman "The Internet changes everything." Although this might have been an overstatement just two years ago, it is clearly not so today. The impact of the Internet is obvious in business-to-consumer transactions: witness the proliferation of Web sites for facilitating sales and services across a broad range of offerings. But the real revolution is happening in businessto-business value chains as companies restructure their operations with trading partners. The Internet also has had a profound impact on the valuation of individual companies and economic sectors. This can be seen not simply in the incredible market capitalization of companies whose business models are rooted in the Internet (e.g., Amazon, eBay, Yahoo!, Priceline), but also of companies that provide the technical infrastructure for the Net economy (e.g., Intel, Microsoft, AOL, IBM, Cisco). Such valuations-although highly volatile-are compelling established companies to seriously assess whether they will lose out to relative upstarts that are leveraging their lofty valuations into tangible capabilities through acquisition. The Internet has also evolved beyond personal computers; soon it will be commonplace to access the Net through cellular telephones (Nokia, Ericsson), personal organizers (Palm Computing, Psion), videogame consoles (Sega's Dreamcast or Sony's PlayStation), as well as home appliances (Electrolux, Whirlpool), vending machines (Maytag), and automobiles (GM's Onstar and Microsoft's AutoPC). In short, the Internet has become more than a simple and effective way to exchange e-mail and documents; it is emerging as a critical backbone of commerce. And, it is happening at a faster pace than many thought possible1 and with which few feel comfortable. But, if you ask managers about the strategies for their Internet businesses, you get a bewildering array of responses. Some mention the functionality of the Web ("you can get the details of our latest new product introductions"); some highlight their choice of platform ("we are driven on the Oracle platform or IBM's e-business infrastructure or Hewlett-Packard's latest suite of eservices"). Some trumpet how they use the Web to enhance customer service ("we provide enhanced customized service-such as specialized pricing and promotions or provide rapid response to customer inquiries"), whereas others point to their success in integrating the physical and digital infrastructures to provide seamless service ("our customers can interact with us in branches, by telephone, or over the Net without any differences in cost or service levels"). Some mention their initial success in creating customer communities ("we now have a regular and continuous dialogue with our customers and this has helped our marketing efforts considerably"). These different observations simply underscore an important characteristic of the Net; its potential functionality is so broad and varied that we cannot and should not restrict our attention to a few narrow domains. Indeed, it is like the proverbial blind men describing the elephant: Different managers see different facets of benefits but do not see the complete picture. Although most managers are cognizant of impending changes, the business landscape is fuzzy and fastchanging. We are navigating in uncharted waters. How should companies develop effective strategies in such a situation? Four interrelated issues are useful in orchestrating conversations about the dot -com agenda. Effective strategizing for the dot-com business operation requires the management team to consider these issues together, not in isolation. Too often, companies focus on one dominant issue and let it be the driving force while paying scant attention to the other issues only to realize the ramifications and conflicts much later. The four issues and the fifth alignment challenge can be posed as questions:
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1. What's your strategic vision for the dot-com operations? 2. How do you govern the dot-com operations? 3. How do you allocate key resources for the dotcom operation&;, 4. What's your operating infrastructure for the dotcom operations? 5. Is your management`team aligned for the dot-com agenda? Consistent answers to these five questions indicate an effective strategy for the dot-com business operations.
1. What's Your Strategic Vision for the Dot-Com Operations?

Even as recent as early 1998, most companies saw the Net as being only tangentially relevant to their business operations. Today, they realize the possibilities and opportunities but are daunted by the challenge of how to make the Internet and e-commerce an integral part of their business strategy rather than a standalone project. Articulating a strategic vision for dot-com business in precise terms is futile; the Net is evolving at such a dizzying pace that it's nearly impossible to work towards a specific end-state. It's more useful to approach the issue of strategic vision for dot-com operations as a continuous cycle involving building on current business models and creating future business models through selective experimentation. The aim is to balance refining the current business rules while creating new business rules for the dot-com agenda. Build on Your Current Business Models For every corporation, the Net -at minimum-offers opportunities for reducing operating cost levels and/or enhancing services. Every company should identify ways to leverage the Net for restructuring the cost base. Even companies that don't find their business-to-customer interactions easily portable to the Net could find value in business-to-business transactions through restructured supply chains. Cost Leadership. Strategy has always relied on cost differentials2 and the Net does not negate this fundamental strategy axiom. Indeed, the Net exposes the inherent weaknesses of high-cost competitorswhether they are big or small. Jack Welch, the legendary chairman of GE, has already sponsored a 90day, all-company initiative under the banner of "destroyourbusiness.com" for thinking about how to use the Web to eliminate bureaucracy. In every conceivable case, the cost of Web-based transactions is an order-of magnitude lower than traditional ways and decreasing at a faster rate. The cost of an Internet-based banking transaction is about onefiftieth of the cost of a human teller transaction. New breed stockbrokers like E*TRADE and Ameritrade have inherently lower cost levels and are forcing traditional players, such as Merrill Lynch, Schwab, and Fidelity, to dramatically lower their price points. We will see more such cost-based competitive pressures in many other sectors of the economy. The centrality of cost leadership in the dot-com arena can be best seen in the personal computer marketplace-where net-savvy customers look for the best value, and the stock market ruthlessly punishes highcost operators with lower capitalization. Dell has consolidated its market superiority by migrating its buildto-order model to the Web3-forcing companies like Compaq, NEC, Sony, and Toshiba to radically restructure their operations to avoid being left behind. Cost leadership is also relevant in other markets-automobiles (with the introduction of autobytel.com,
The Dot-Com Agenda as a Balancing Act
Microsoft's carpoint.msn.com, and autoweb.com), electronic goods (gigabuys.com), toys (etoys.com), and others. The two major online travel agencies (Travelocity and Preview Travel) have recently merged to further consolidate their operations and reduce the cost of online bookings. Web-supported, low-cost airlines are springing up in Europe (easyjet.com). Companies not pursuing cost-based advantages through the Web will be left behind in the massive sea change under way. Enhancing Services. The dot-com operations allow for enhanced services. We have come a long way since FedEx introduced us to the possibilities of tracking packages over the Net. Today, customers expect logistics companies to make their inventory chain visible. Placing content on Web sites is a powerful differentiator: Customers can now get critical information at their convenience. Indeed, customers expect timely updates (delivery schedules, product updates, account information), product enhancements (patches for software glitches), rapid resolution of problems not found in the FAQ list (through e-mail and remote-monitoring capabilities), as well as personalized interactions through customized navigation paths on company Web sites (see, for instance, Dell, GM, and Toyota). American Airlines' new AAlert e-mail service tells specific customers when their chosen destinations or departures are featured in special deals. Other airlines are scrambling to provide similar service features. Cellular phone customers can modify, adapt, and upgrade ringing tones (nokia.com), and consumers can see breaking news footage at their own convenience (cnn.com, bbc.co.uk).4 Companies will further enhance personalized service as more and more devices are connected to the Net.5 Nextgeneration home appliances such as refrigerators, washing machines, and microwave ovens will be connected to the Net as homes become wired and smarter.6 Create New Business Models The power of the Web lies in the creation of new business models. It has become fashionable to talk of "new business models" when discussing the Net-this phrase has emerged as a catchall way to highlight the impact of the dot-com operations. We do need to be more precise: New business models are those that "offer, on a sustained basis, an order-of magnitude increase in value propositions to the customers compared to companies with traditional business models." In doing so, these new models disturb the status quo and create new rules of business. Traditional companies cannot easily match the value propositions offered by these new business models
without substantially altering their margin structures. They also find it difficult to go beyond incrementally refining the current rules to create radically different rules. However, an important part of the strategic thinking for every company is to develop scenarios of new business modelseven though they might challenge the status quo and cannibalize current revenue and margin streams. Look at the music marketplace: The big four, Universal, BMG, Warner EMI, and Sony-now control about 80% of industry sales, and online distribution accounts for about 1% of sales, representing the sale of CDs by mail order. But the availability and increased acceptance of music players that use the mp3 format (mp3.com) are likely to create major disruptions in the economic landscape. As more Internet sites (Amazon recently entered the fray) support the downloading of music onto mp3-compatible devices (see, for example, the Rio player, at rio.com), every major record label needs to rethink its business models. Featuring more than 25,000 performers affiliated with over 100 independent labels, mp3.com enjoys a market capitalization of over $2 billion and has been legitimized by Sony's decision to make a version
The Dot-Com Operation as a Cyclical Reinvention
of its popular Walkman that will play music in the mp3 format. The major labels are already responding with their own aggressive plans, which include abandoning traditional music formats. It is a far cry from listening to vinyl records on turntables! The music marketplace is not an exception. The retail financial services industry is changing with multiple players from historically disparate segments jockeying to create new business models. Priceline.com is revolutionizing travel and related services by letting customers specify their desired prices and serving as a mechanism for competing companies to bid for customer requirements. It started with airline tickets and has since expanded to cover hotel rooms, home financing, and new car purchases and leases. Their model of "buyer-driven commerce" is supported by a string of patents and could prove to be a powerful new business model. Amazon is more than an electronic bookseller. New market mechanisms that incorporate auctions (see, for example, freemarkets.com) are beginning to challenge industrial companies. New electronic aggregators are also emerging in many areas such as steel (e-steel.com) to reduce inefficiency and redistribute value. Indeed, one is hardpressed to think of markets that may be unaffected by the Net. We clearly have not reached a steady state, and it is unclear whether we ever will.
Experiment with Scenarios So, what should companies do? We need to abandon calendar-driven models of strategy perfected under predictable conditions of the Industrial Age. We should embrace the philosophy of experimentation since the shape of the future business models is not obvious. The strategic challenge is to spearhead experiments7 to assess probable future states and migrate operations to the desired state. Establishing the vision and rationale for these experiments including the mandate to proactively cannibalize current business models-is a critical hallmark of leadership for the dot-com world. Coordinated experimentation is required to develop the building blocks for success in the dot-com arena. Leading consumer-product companies are now assessing the strength of brand equity and brand pull in the Web world. Having established a credible brand franchise in the physical space, Gap is now experimenting with gaponline.com. But will it translate well on the Web? Somewhat unconnected with Procter and Gamble's major brand names, the company has unleashed a new unit to create custom-designed cosmetics (reflect.com) along the lines of Dell's build-to-order approach. Nike-a brand leadership phenomenon of the late twentieth century -is trying to create consumer pull through custom-designed shoes (www.nike.com/id) and through its strategic alliance with fogdog.com-an online sports gear retailer. Unilever, Kraft Foods, P&G, and other global consumer-products companies are also seeking to port their operations to the Net. Experimentation is not limited to rethinking brand equity. Look at retailing-a market that has seen major disruptions caused by Internet versions of category killers. Current leaders in the traditional marketplace are experimenting with ways to defend their market positions while adapting their strategies for the Web (see, for instance, toysrus.com, walmart.com, nordstrom.com, and sears.com.) Even top-line niche players like Tiffany's and Harrods are experimenting to identify the best possible ways to migrate their operations to the dot-com world without diluting their brand image. Publishing is much the same-likely to be significantly reshaped by the Net, even though dominant new business models with assured profitability have yet to emerge. Today, we have the dot-com addons to paper-based publications (see, for example, fortune.com, businessweek.com, ft.com). Experiments to assess the likelihood of revenue generation from online publication (such as The Wall Street Journal interactive edition, wsj.com) are under way with no conclusive results; yet, the publishing industry cannot afford to neglect the Net. These experiments require more than merely porting their print content to the Web; they involve rethinking the distribution of content as well as restructuring relationships to integrate content from multiple sources. In television and broadcasting, NBC is leading the way beyond conventional broadcasting and has already created a portfolio of experiments. Witness msnbc.com, its partnership with Microsoft to combine cable and the Internet. It has also created nbc.launch.com to focus on music, and has recently combined all of its activities under NBC Internet, to coordinate its Web experiments. CNN.com is partnering with WebMD to become a health-information portal for its customers (www.cnn.com/health). Indeed, all leading television networks are experimenting with different ways to incorporate the Web as part of their strategy. Selective strategic experimentation is the sine qua non of strategy formation8 for the dot -com world. However, a major danger is that these experiments could be seen as standalone tangential projects decoupled from the mainstream operations. It is important that they be seen as building blocks for migrating and transforming the corporation to the dot-com world. Strategic experiments-when properly conceived and executed--can reveal powerful new ways to succeed in the dot-com world, where history offers little guidance.
The Bottom Line: A business strategy that fails to recognize the Net is destined to fail. Past success is no guarantee of future success, and calendar-driven strategic planning is giving way to strategic experimentation and rapid adaptation. The challenge is to pursue experiments that not only augment current business models but also create new business models and rules of competition.
2. How To Govern the Dot-Com Business?

The challenge of how best to govern the dot-com operations is daunting. Managers must attract and retain key management talent; they are intrigued by the differential market valuation of dot com operations and are struggling with the requirement to give adequate management time and attention to the dot-com strategy and operations. At the same time, they find that the dot -com operations differ from their traditional operations and find it difficult to reconcile them. Two major categories of decision influence the governance mode: operational decisions (production, sourcing, logistics, marketing, and human resources) and financial decisions (investment logic, funding sources, and performance criteria). The governance of dot-com business is best seen as a trade-off between these two categories: how firms differentiate and integrate operational and financial decisions. The basic governance choices can be arrayed along the diagonal as a continuum from subsidiary (spinoff) at one end and seamless (transparent) at the other end. Decoupling Your Dot -Com Operations and Finances When faced with the fast-paced changes unleashed by the Net, managers may benefit from differentiating the operations and decoupling the financial arrangements. Take the case of Nordstrom.com-the newly created subsidiary of Nordstrom formed to accelerate the growth of its Internet and catalog direct sales but with minority funding from Benchmark Capital. The new subsidiary-Nordstromshoes.com-is aimed at selling leading brands of shoes. The funding from the venture capital community allowed the subsidiary to invest in site development and to create the appropriate software as well as a distinct advertising campaign-without being handicapped by the requirements of using only internally generated resources. In a related vein, Wal-Mart.com is being contemplated as a separate company with funding from Accel Partners.9 This governance mode makes sense under the following conditions: (1) the company is willing to explore new business models apart from the constraints of current operations; (2) the subsidiary or spin-off can be created without being constrained by current technology and legacy operations; and (3) the company bestows the subsidiary with the freedom to form alliances, raise capital, and attract new talent. Morphing Otd Practices into New Ones Now let us look at the other end of the continuum where operational and financial decisions of the dotcom operations are intermingled with the traditional business domain. In some cases, differentiation of the dot-com operations may be inappropriate, because it could dilute the level of management attention needed to ensure success. The dot-com operations are seamlessly integrated as the traditional company morphs to become the dot-com company. Take a look at Encyclopedia Britannica (eb.com): It was an undisputed leader in its category, experimented with CD-ROM, and has finally evolved into a dot-com operation by making its content available free on the Net. Cisco is a dot-com company whose operations cannot be segregated into dot-com and non-dotcom components. As CEO John Chambers observed: "In 1998, Cisco is the best example of a
company using the Internet technology to gain a sustainable competitive advantage with over 70% of customer inquiries handled online and 64% of orders placed via the Web.10 Cisco may be leading the pack, but it is by no means alone. Intel is a dot -com company with more than 40% of sales conducted through the Net. As Intel Chairman Andy Grove remarked: "In January 1998, the company had exactly zero customers on line. Phones, faxes, and overnight parcel carriers served as the conduits for placing orders. By June 1999, over 560 companies in 46 countries were using Intel's Web-based order-management system to place orders, track deliveries, post inquiries, and get product and pricing updates. Today, this system produces nearly $1 billion in sales per month."11 This seamless governance mode makes sense under the following conditions: (1) There is no meaningful way to separate digital and physical operations without creating confusion in the minds of customers. (2) Senior management is committed to embracing the opportunities and challenges of the Net to redefine the value proposition as well as aggressively react to competitive moves. (3) The entire organization can be mobilized to migrate to the dot-com world (as Egghead Software did when it abandoned its physical presence in the retail software market to migrate to the digital world with egghead.com). Finding Your Place on the Governance Continuum Different companies rightfully choose different governance models depending on their views of the centrality of the dot-com operations. Lloyds TSB, the United Kingdom's largest bank, has decided to keep its dot-com operations integrated-for the moment but with a different brand identity. In contrast, Bank One, a leading U.S. retail bank, with its Wingspan bank and Halifax with its Greenfield.co.uk established their dot-com operations as separate subsidiaries. Governing in the dot -com world depends on a dynamic interplay between the two decisions on this continuum. It can be understood through two transition paths: One is to leverage financial instruments and the discipline of financial markets, whereas the other is to restructure relationships-both internally and with alliances and partnerships. The financial leverage transition path allows companies to exploit two popular mechanisms: (1) issuing separate stock through an initial public offering (IPO) of the dot-com operations and (2) infusion of external venture capital funds. Dixon's in the United Kingdom floated 20% of its Freeserve Internet Service Provider (ISP) operations as a separate stock (ticker: FREE), which had, at its peak, a market capitalization of about $8 billion. Prudential, the UK life insurance company, is in the initial stages of floating its Internet -only banking operations. Playboy Entertainment plans to tap the financial market for its dot-com operations. Microsoft, the market capitalization leader, has spun off its Expedia Internet travel business as a separate company (ticker: EXPE). In the words of Brad Chase, senior vice president of Microsoft's consumer and commerce group, the IPO would allow the business "to use its resources to partner with other people, to buy other Web sites, and grow its vertical marketplace."12 NBC Internet is a separate trading stock (ticker: NBCI) with a market capitalization of more than $4 billion. These initiatives reflect an important strategic consideration: the financial markets bring external discipline to governance that is critical under fast-changing conditions.13 An alternative to the use of tracking stocks is to pursue private placement through venture capitalists. Venture capitalists such as Kleiner Perkins and Benchmark Capital are aggressively working with traditional companies that are developing dot-com operations; their aim is to unleash hidden value in those assets that may not have been properly governed and, hence, are inadequately valued. This is an interim position before taking the dot-com operations public. Indeed, the question of whether to infuse external
venture capital to spearhead the dot-com operations is a key strategic issue facing every company today.
Dot-Com Trade -Oils
The relationship leverage transition path focuses on organizational arrangements to bring the governance issue into sharper focus. When General Motors created a separate division, e-GM, it signaled a major commitment to the Internet as a future business platform. This unit is responsible for coordinating all the dot-com initiatives, including its OnStar initiative, to establish the individual car, itself, as a portal. It is testing the shape and scope of this e-franchise and the role of retailers in the revamped value chain of the dot -com world. GM's Vauxhall division in the United Kingdom, a major initiative of e-GM, is perhaps the first automotive company to announce a set of six models for sale only on the Web. To consolidate its Internet initiatives, Kraft Foods has created a separate organizational unit, which is one step short of a subsidiary, because Kraft does not radically separate the financial decisions. It provides an organizational context to question possible areas of cannibalization, as well as to coordinate multiple experiments taking place in the dot -com arena. Raising the organizational level of attention to the dot-com operations is an essential step in crafting a coherent strategy, because multiple conflicting decisions must be coordinated across traditional and dotcom spaces. The transition to the dot -com world is not limited to internal restructuring, but also involves alliances and partnerships. Ford Motor Corporation is exploring the potential of the Internet in its marketing activities in partnership with Microsoft. Sotheby's is jumpstarting its dot-com operations by forming an alliance with Amazon.com to expand its auctions business beyond its traditional high-end collectibles (see sothebys.amazon.com).
Clearly, these two transition paths are complementary ways to position along the governance continuum; this is not a static decision since a mode of governance is only appropriate for a given context, and the context is fast-changing in the Internet world. Recognizing the complementary roles of both financial and organizational instruments in this dot-com world is key. We may see Disney spinning off its Buena Vista subsidiary, we may see the Ford-Microsoft relationship evolve into a separate business primed for IPO, and we may see Walmart.com as a separate stock. Clearly, the governance of the dotcom operations for every corporation is a critical management issue that could either unleash or constrain the hidden value of core assets in this time of profound transformation. The Bottom Line: More than understanding the potential challenges and opportunities posed by the Net, the biggest stumbling block for an effective strategy will be lack of adequate attention to the governance issue. In Internet time, mistimed and ill-prepared strategic moves can be costly. Pursue financial and relational leverage paths to continually fine-tune the governance position along the continuum between subsidiary (spin-off) and seamless (transparent) modes.
3. How Do You Allocate Resources for the Dot-Com Business?

Closely related to governance is the allocation of resources: how best to assemble and deploy the key resources for succeeding in the dot-com world. One manager in a major corporation remarked that "...the dot-com operations is a war for talent; it is a war for three types of resources-human, technological, and financial." It is a war because traditional companies need these critical resources to migrate their operations to the Net, and new entrants seeking to establish their superiority in the new world also need them. The new Internet startups are attracting young talent away from established industries-witness the profile of recent graduating classes in top universities joining Silicon Valley startups, and look at the roster of corporate big names joining Internet startups. Startups enjoy an edge over traditional companies. They are leveraging their newly established wealth to acquire resources that the traditional companies find it difficult to match. Four different but interlinked approaches are required for assembling and deploying the required resources. Placing Strategic Bets Here the company commits internal resources to dif ferentiate its dot-com operations from those of competitors. These resources may be financial, technological, or human. Bank One has publicly indicated that its growth in traditional areas will be marginal and has redirected its resources to dominating the online world (bancone.com). Electrolux is betting that it can control the kitchen network in the era of networked kitchens. John Deere is pursuing precision farming so that operators who are using tractors connected to the network receive real-time guidance on services. Nike is betting on selling customized shoes through the Net, and Maytag wants to establish superiority in Net-enabled vending machines. The leaders in the traditional world, such as GE, NBC, CNN, Pearson, Wal-Mart, SKF, Citicorp, and Kraft Foods, are making significant strategic bets in dot-com experiments. From a human-resource point of view, the real challenge is to stem the impending brain drain away from the traditional established companies towards the dot-com startups. A former WalMart senior officer now runs Amazon.com's logistics. George Shaheen of Andersen Consulting now runs WebVan. Companies such as GE, IBM, and British Telecom have lost senior managers to Web startups. What are the key human resources required to run the dot-com operations, and what changes in incentives are required to make this happen? Articulating these strategic bets is absolutely critical.
Strategic bets should be placed on a set of probable opportunities instead of predictable ones. When investments in the dot-com world are viewed as real options, companies can potentially invest in a broader range of opportunities than otherwise.14 Instead of fully funding a smaller set of relatively predictable projects, the aim should be to acquire a set of options with rights to acquire and leverage certain capabilities, should they prove successful. Learning How to Leverage Your Alliances Differentiated capabilities can be created through alliances and partnerships. The dot-coin operations are by definition networked and call for assembling complementary strategic capabilities through relationships. Pearson, the United Kingdom's media giant, is forming a strategic relationship with AOL, and its importance is signaled by the fact that Pearson's CEO now sits on the AOL board. Yahoo's success is based on its portfolio of alliances. Microsoft is a master at exploring multiple avenues for acquiring resources through mechanisms such as equity investments, cross-licensing, joint development, and ventures. More than ever before, it is the pattern of strategic alliances and relationships that indicates strategic strengths in the dot-coin world. These alliances are not limited to the players in the physical world linking up with dot-coin players. Even first-generation dot-coin companies such as Amazon, Priceline, and eBay are steadily evolving and refining their alliance structures to redefine their business models. Amazon's equity investment in drugstore.com is another case in point. A new breed of firms like Viant (viant.com) actively collaborates to build digital businesses for companies such as American Express, BankBoston, Compaq, Radio Shack, and Kinko's. These alliances will reflect more joint profit sharing rather than fee-for-service. For instance, Sony is working with EDS to create, design, and build the Metreon entertainment center Web site (metreon.com), one of Sony's dot-com initiatives, and EDS will receive a share of the revenues. We will see more alliances -with risk-reward sharing-for accessing and deploying resources in the dot-com world. Consulting companies that are building digital businesses will move away from fee-for-service toward equities and risk-reward sharing. This trend will continue at a faster pace.
Interlinked Approaches to Deploy Dot-Com Resources
The dot-com operations are network-centric. Hence, they call for strategic approaches that are not anchored on resources inside the firm but fundamentally involve resources acquired and leveraged in a network of relationships. They call for strategies to be seen as a "portfolio of capabilities that are acquired and deployed through a portfolio of relationships." This is a far cry from strategy seen as primarily resource deployments inside the firm. Positioning and navigating in a complex network of resources is a hallmark of differentiation for companies like Amazon, Yahoo, AOL, and Microsoft. Outsourcing Dot-Com Operations and Maintaining Operational Parity These are areas of the dot-com operations in which activities like Web hosting, back-end processing, and order fulfillment can be conducted outside the firm. More than in the traditional world, dot-com operations (by virtue of their networked infrastructure) allow for complementary players to be easily linked. Companies increasingly find it easier to rely on standard services from established players like IBM, HP, Oracle, Microsoft, EDS, and AT&T so that they can build their operations on a robust and stable platform. Given the rate of change in technology and the impressive cost-performance shifts, it is more important to rely on best-in-class providers rather than create these operations inside. Whether or not you outsource, your IT support operations must achieve competitive parity. Resources should be allocated on the basis of predictable models and supported by techniques such as activity-based costing. The aim is to ruthlessly achieve the lowest operating costs for the required level of functionality, as well as to evaluate possible risks and rewards of outsourcing.
The Bottom Line: Effective strategies for the dot-com world are based on the pattern and timing of resource deployment. The overall logic of resource allocation for the dot-com is different from the predictable models of the physical world. Assemble resources from multiple sources and manage them on a dynamic basis.
4. What's the Operating Infrastructure of Your Dot-Com Business?

The next major requirement is to design the operating infrastructure. It is tempting to describe its technical characteristics by saying that "we are wired" or "we are net-enabled" or "we are digitized." More importantly, we need to understand the characteristics of the infrastructure that provide value for customers-the features that draw customers to the dotcom world and encourage them to continue to use the Net as a primary way of using products and services. The first wave of the Internet was about the number of computers connected to the Net which ushered in the network economy." The second wave is about relationships and business models that leverage the key characteristics of the network economy.'6 These business models straddle the traditional and dot-com spaces for delivering superior customer value propositions. Hence, the infrastructure could either support the strategy or fail. It is useful to look at the operating infrastructure as four building blocks that reflect an integrated physical-digital platform. Attaining Superior Functionality Do customers find their online experience supported by the appropriate functionality? Better quality images, audio clips, and 3-D rendering have enhanced the power of the Web to be realistic. (See Web sites using the functionality offered by Real Networks-realnetworks.com-or Macromediamacromedia.com.) Take, for instance, the sale of a Gulfstream corporate jet for about $23 million: Elite Aviation bought a jet from gulfstreampreowned.com after a virtual inspection using 360-degree interactive video technology from Interactive Pictures Corporation (ipix.com). As technology evolves, we will see far greater functionality-especially as wireless applications protocols (WAPs) become commonplace and wireless devices like cellular telephones and personal digital assistants (PDAs) are connected to the Net. United Parcel Service tracking is now possible on a Palm VII. The music industry will be reshaped by emusic.com, mp3.com, and others. Television will be altered when new initiatives such as replayTV, which records specified shows on a hard disk, are more widely adopted. Changing functionality will make dot-com operations appealing to a broad range of companies and customers. Offering Personalized Interactions Can we make each customer feel unique on the Net? The appeal of the Net lies in its personalization potential. Customers want to be connected to other customers (C2C interactions) and appreciate personal business-to-customer (B2C) linkages. We see this in popular sites such as My Yahoo!, My Schwab, and My Dell. The challenge is to encourage each visitor to establish a Web-based personal identity without invading privacy. Amazon.com shot into prominence early with its personalized recommendations. Now, many consumer sites incorporate personalization of some kind. Personalization will become increasingly important as more devices connect to the Net: Think about automobiles and cellular phones connected to the Net (D2D interactions). Significant opportunities and challenges await those who design operating infrastructures that support virtual extensions of the customer.
Streamlining Transactions The power of the infrastructure lies in its simplicity and efficiency. Increasingly, the winners will be differentiated by their ability to execute streamlined transactions: Amazon pioneered and patented one-click settings-an important differentiator in its bid to establish supremacy. A single, secure way for customers to sign in to multiple Internet sites using one member name and password, Microsoft Passport (passport.com) streamlines processes and delivers personalized value. SAP is creating many modules to port business processes to the Web (mySAP. com). Consider FedEx, which gave customers immediate access to transactions and delivery status. Dell took it one step further and allowed its customers to see the status of their custom-built machine at every stage of the cycle. Now car manufacturers want to adopt similar functionality to streamline operations. Indeed, for B2B activities, streamlined transactions and cross-sharing of information become central as the firms strive for radical improvements in efficiency. The weaknesses in legacy operations will be exposed in this arena. For instance, data updates should be on a near-continuous basis-especially when selling time-sensitive perishables like airline or concert tickets. Similarly, Internet-only banks, such as wingspan.com, must substantiate their claims of making 60-second mortgage decisions without increasing the banks' financial exposure. Product configurators for personal computers and cars, for example, must be linked to the production-planning system so that firms can accurately provide delivery dates and prices. Streamlined operations require a reliable infrastructure. Commerce in the last century has been facilitated by the increased reliability of telephone and telecommunications (think about the reliability of telephones and ATMs) and logistics (FedEx, UPS, and rail carriers have contributed to modern supply chains). Reliability plays a key role in enhancing customer confidence: When sites like E*TRADE and Schwab-which account for an increasing share of stock market tradingare offline, they weaken not only their customers' confidence but also cast doubt on the dot-com movement. 17 As more devices connect to the Net and as more functionality is processed through the Net, reliability will emerge as a major catalyst for Net -based business and a key differentiator for individual companies. Ensuring Privacy "Will my transactions be secure? Will my information be safeguarded?" The idea behind "pragmatic privacy" is to convince customers that their privacy will be safeguarded and used only for the purpose of delivering superior value to them. Privacy emerges as a major inhibitor because customers still are not comfortable with electronic transactions. Credit-card companies have played an important role in offering the same level of protection on the Web as in the physical space, and the browser software companies (Microsoft, Netscape) have incorporated critical safety features into their latest software. Demonstrating the power of various encryption protocols in ways that customers understand will go a long way, but security is more about consumer perception than technical features or protocols per se. Companies like GE are embracing leading security encryption protocols-for example, the RSA Keon AdvancePublic Key Infrastructure software for digital certification (rsasecurity.com). Others are adopting Verisign (verisign.com) or digital original certificates, such as eOriginal, which are created for various applications (eoriginal.com). Privacy is closely related to security. Customers become concerned about privacy"8 on the Net, due in part to the proliferation of software cookies that help Web sites learn about visitors such as DoubleClick (doubleclick.com) and Firefly Passport (firefly.net). These companies have gone out of their way to make customers feel comfortable about their safeguards to privacy. But the real responsibility lies with the companies that use these software cookies. Sites like GM OnStar (onstar.com) or GE (ge.com) explicitly state how they plan to deal with privacy issues, and some audit firms are also beginning to offer services as trusted third-party guarantors of how
companies safeguard customer data. Being forthright with customers about privacy will go a long way in enhancing use of the Net. The Bottom Line: Digital infrastructure should be designed and deployed to enhance customer value propositions. Design the infrastructure so that dotcom operations make it easier for customers to do business without sacrificing customer trust about reliability, security, and privacy. Straddle physical and digital spaces with relevant linkages to partners and alliances to offer a seamless and effective way for conducting the business.
5. Is Your Management Team Aligned for the Dot-Com Agenda?

Who leads the corporation to the dot-com world? Is this an opportunity for the senior IT manager to earn the right to become a member of top management? Or is it the marketing manager who articulates how the customer value propositions can be redefined? What roles should the CEO and COO play? Articulating the roles of key members of the management team is central in shaping the strategy of the dot-com operations. Many companies treat their dot -com operations as a project: certain boards of directors feel relatively comfortable delegating responsibility for carrying out the dot-com "project." Some see this as an extension of technology-led business initiatives. The words of a frustrated manager capture it best: "The board seems to think that this is like implementing SAP-fund it, delegate it, and ensure that we do not hear about it until it is implemented. This is far different from SAP; we are not just trying to automate and integrate our business processes in a standardized way; we are trying to create new value propositions for customers... and we can't manage it like another project-decoupled from serious discussions and fundamental choices and commitment from the board."
Putting Together a Dot-Com Operating Infrastructure
Thinking Like a Dot-Com: How a Consumer Products Company Can Develop Its Web Strategy
The dot-com operations require a pattern of leadership alignment that differs greatly from other business transformation activities. Even business reengineering efforts billed as major transformational projects pale in comparison to the tasks and challenges pertaining to the dotcom operations. This is because most reengineering projects-despite claims to the contrary-focus on rectifying weaknesses in the current business models. Very few companies have truly created or redefined their business for the wired, digital world. In contrast, the dot -com world is about value creation. It involves strategic challenges of business creation; important governance issues of organizational structure; and new avenues of financing, changes in operating infrastructure, external relationships, and patterns of resource department. I can't emphasize enough the importance of senior management alignment in mobilizing the organization to recognize and respond to the dot-com world. Ask each key member of your management team to identify who plays the leadership and supporting roles for the four preceding questions. Such an exercise may help the managers recognize and accept that mobilizing the organization is a team issue and that everyone plays complementary roles. Without overly stereotyping management roles, such a table-only an illustrative approach shown here-an be helpful in orchestrating a constructive dialog within the management team. If the management team is not in sync, it is easy for the dot-com agenda to be hijacked by one or two members reflecting a partisan, parochial perspective. Every company needs a champion to get started, but it needs more than one champion to succeed. It is encouraging to see many
leading companies already embracing the dot -com world. But it is more than Web sites; more than promises to consumers. It is more than merely grafting the Web on as part of business strategy; more than paying lip service to the projects that deal with electronic commerce. It is a serious challenge with profound opportunities and threats to the status quo. Succeeding in the Dot-Com World New companies with an Internet focus have grabbed the headlines. Employees and stockholders of these startups have reaped the benefits of new wealth. At the same time, stalwarts like Jack Welch of GE, Jack Smith of GM, and Harvey Golub of American Express have unleashed creative energies within their corporations to develop dot-com visions.l9 Some have recognized the value of the Net for B2B transactions, whereas others have focused on B2C transactions. And as new devices emerge and become part of the critical backbone for dot-com operations, every company will need to develop a strategy for the dot -com world. Ultimately, business strategy will be dot -com strategy. Andy Grove wrote a book titled Only the Paranoid Survive.20 He wrote it before the onslaught of the Net. But his thesis is apt for anyone thinking about dot -com business. We are in the midst of major shifts: Traditional logic, so fundamental to the industrial revolution, is challenged every day by the possibilities of the dot-com world. Well-understood sources of value creation through tangible, physical assets are being replaced by newfound sources through digital assets and networks of relationships. Every market-from agriculture to automobiles to financial services, entertainment, and healthcare-is affected by interactive technology. New entrants are crafting powerful new business models and rewriting the rules of competition. Established companies urgently need to embrace the dot-com agenda; failing this, they will be left behind. They need to blend their traditional and dot-com operations while confronting the challenge of brain drain as their top talent jumps ship for other dot-com operations. The game is far from over, and we will see powerful transformations as companies embrace the Net and craft innovative strategies that successfully blend physical and digital infrastructures. It's up to managers to take the necessary actions to align their visions to the dot-com world. While it is too early to declare the leading corporations of the Industrial Age to be the dinosaurs of the digital era, clearly they face daunting challenges.
Complementary Management Roles of a Dot-Com Operation Might Look Like This References 1. For example, see: M. Cusumano and D. Yoffie, Competing on Internet Time.: Lessons from Netscape and Its Battle with Microsoft (New York: Free Press, 1998).
2. M. Porter, Competitive Strategy/New York: Free Press, 1980). 3. M. Dell, Direct from Dell /New York: Harper Business, 1999). 4. Personalization and dynamic customization are important avenues for redefined customer interactions in the post-industrial world. See: N. Venkatraman and J.C. Henderson, "Real Strategies far Virtual Organizing," Sloan Management Review volume 40, Fall 1998, pp. 3348. See also: D. Peppers and M. Rogers, Enterprise One to One: Tools for Competing in the Interactive Age (New York: Currency Doubleday, 1997). 5. The latest version of Palm Computing's Palm VII has infrared wireless capability to access the Net, and a variety of services and accessories will support this platform. 6. For a broad overvie w, see: N. Negroponte, Being Digital (New York: Knopf, 1995). For up-to-date views, see: nicholas.www.media.mit.edu/people/nicholas/. See also: N. Gershenfeld, When Things Start to Think(New York: Henry Holt, 1999; and also see Gershenfeld's Web site: www.media.mit.edu/ttt. ' 7. For an elaboration of this view, see: G. Hamel and J. Sampler, "The E-Corporation," Fortune, 7 December 1998, pp. 80-92; and G. Hamel, "Bringing the Silicon Valley Inside," Harvard Business Review volume 77, SeptemberOctober 1999, pp. 70-84. 8. For a good general discussion of the role of experimentation, see several articles in the fortieth anniversary issue of Sloan Management Review In particular, see: C.C. Markides, "A Dynamic View of Strategy," Sloan Management Review, volume 40, Spring 1999, pp. 55-63; E.D. Beinhocker, "Robust Adaptive Strategies," Sloan Management Review, volume 40, Spring 1999, pp. 95-106; and PJ. Williamson, "Strategy as Options on the Future," Sloan Management Review, volume 40, Spring 1999, pp. 117-126. 9. Miguel Helft, "Wal- Mart Teams Up with Accel," Industry Standard, 6 January 2000 (www.thestandard.com/article/ display/0,1151,8649,OO.html). See also: www.accel.com/news. 10. J.T. Chambers, "The New Economy Is the Internet Economy," white paper (San Jose, California: Cisco Systems, 1998); and see: http://www.cisco.com/warp/public/750 /johnchambers/internet economy/. 11. See www.intel.com for speeches by Andy Grove and other Intel senior managers. 12. Alex Lash, "A New Strategy for MSN. Again," Industry Standard, 27 September 1999 13. For a detailed discussion on the role of financial markets in disciplining decisions, see: M. Amram and N. Kulatilaka, "Disciplined Decisions: Aligning Strategy with Financial Markets," Harvard Business Review volume 77, January-February 1999, pp. 95-104. See also: M. Amram and N. Kulatilaka, Real Options: Managing Strategic Investments in an Uncertain World (Boston: Harvard Business School Press, 1999). 14. Real options have emerged as a powerful approach for dealing with resource allocations under uncertainty. See: N. Kulatilaka and N. Venkatraman, Real Options in the Digital Economy(Financial Times Mastering Management Series, September 1999; also see: www.real-options.com; K. Leslie and M. Michaels, "The Real Power of Real Options," McKinsey Quarterly, number 3, 1997, pp. 4-22; and www.mckinseyquarterly.com. 15. See, for example, Kevin Kelly's Wired magazine columns; and K. Kelly, New Rules for New Economy(New York: Viking Books, 1998). For discussions on the information economy, see: C. Shapiro and H. Varian, Information Rules (Boston: Harvard Business School Press, 1999). 16. New business magazines, such as Business 2.0(www.business2.com), deal with the creation of business models for the new economy. See also: W ired(www.wired.com); and Fast Company (www.fastcompany.com). 17. This is evident in the volatility of the stocks of those dot-com companies whose sites have experienced outages. 18. See, for example: A. Cavoukian and D. Tapscott, Who Knows: Safeguarding Your Privacy in a Networked World (New York: McGraw-Hill, 1997). 19. See, for example: E. Brown, "Big Business Meets the e -World," Fortune, volume 140, 8 November 1999, pp. 88-98. For articles dealing with how established companies are striving to respond to the dot-com agenda, also visit Fortune(www.fortune.com); and The Economist (www.economist.com). 20. A.S. Grove, Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company (New York: Random, 1996).
Author note
N. Venkatraman is a visiting professor of strategy and international management at the London Business School, on leave from Boston University, where he is a professor of management, Information Systems Department. Contact him at: venkat@bu.edu or nvenkatraman@london.edu.
Making business sense of the e -opportunity

Mit Sloan Management Review; Cambridge; Winter 2001; David Feeny Most corporate executives are convinced by now that the scale and pervasiveness of today's technological change require a fundamental review of business strategy. Web-based technology through the Internet, intranets and extranets - offers universal connectivity at astonishingly low cost, with a simple, standardized user interface. The new technology is creating opportunities to rethink business models, processes and relationships along the whole length of the supply chain in pursuit of unprecedented levels of productivity, improved customer propositions and new streams of business. But the scope of the potential for change is daunting. The burgeoning e-business literature bombards executives with ideas competing for their attention. It is hard to make collective sense of it all or to know where to start the strategic analysis. Moreover, e-business ideas are described in unfamiliar terminology - "portals," "infomediaries" and "aggregators" in "B2C/B2B/BTE" settings. Behind the new language, how new are the strategic concepts? To what extent are the old dogs of the established economy required to learn new tricks? The success of Amazon.com, Dell Computer, eBay and others served as a wake-up call for many executives. But companies in, say, chemicals, helicopters or credit-card services are likely to find their strategic opportunity taking a different form. A first step in confronting the challenges is to construct a coherent map of the e-opportunity. With the mood swings of the financial markets and the faltering fortunes of New Economy icons, the business community at large still feels uncertainty about the future shape and scope of ebusiness. A comprehensive map of the e-opportunity and its three domains (operations, marketing and customer services) can become a platform for exploring the new strategic landscape. In each domain, the technology can enable a radical new vision of what a business can accomplish. (See "The Domains of E-Opportunity.") E-operations opportunities are uses of Web technology that are directed at strategic change in the way a business manages itself and its supply chain, culminating in the production of its core product or service. For example, technology underpins BP Amoco's initiatives to troubleshoot more effectively by sharing the learning of its businesses around the world. General Electric Co. improved its purchasing by posting requirements on a Web site and having suppliers submit bids electronically. E-marketing opportunities cover Web-based initiatives that are designed to achieve strategic change in downstream activities, either through direct interaction with the customer or through a distribution channel. In e-marketing, a traditional product remains the focus of the business and its revenue generation, but the way the product is delivered or the scope of support services changes. The provider may be a traditional incumbent or a new pure-play entrant: a Barnes & Noble or an Amazon.com, a Toys "R" Us or an eToys. The financial-services sector is illustrative. In that arena, established companies and new competitors are forging links to established intermediary channels, to new intermediaries and to the customer directly - while continuing to focus on the delivery of traditional financial-services products such as savings accounts, credit cards and mortgages. E-service opportunities give companies new ways to address an identified set of customer needs. Rather than promoting proprietary products, the e-service business acts as the customer's agent in achieving a desired outcome. Most current examples are New Economy businesses: Chemdex, the information intermediary in the biosciences sector; OneMediaPlace (formerly Adauction.com), which provides buyers and sellers of advertising space with a radically new set
of services; and shopping robots such as mySimon.com, which scour the Internet to find the best deals available. Some Old Economy businesses float an e-service business as a new venture for example, Overseas Chinese Bank Corporation's Bank of Singapore has a financial-services venture called finatiQ.com. Others may begin to redefine their core business, as Ford Motor Co. is doing in seeking to become "the world's leading consumer company for automotive service."1 Defining e-opportunity domains using a business-oriented perspective and language illuminates the role of new technology in competitive advantage. Technology prompts new business practices rather than new business theories. In other words, successful e-strategies translate established strategic concepts into contexts in which they previously were not economically viable. In the 1960s and 1970s, IBM won the loyalty of major corporate customers through highly paid account executives who provided what IBM called "relationship management.' That approach to supporting individual consumers is now technologically based. Distinguishing between the three e-opportunity domains is critical. Each requires its own distinctive framework for identifying ideas that can bring competitive advantage to a given context. Every business should be considering opportunities across all three domains, but the potential significance of each domain, and of individual ideas within it, will vary widely across businesses and industry sectors. Although it is tempting to begin with the excitement of e-service - the Brave New World of the New Economy - in practice, the e-operations and e-marketing layers require the most urgent attention and provide the most certain rewards. As so many dotcoms have demonstrated, if you have e-vision but a single marketing approach and a poor fulfillment capability, you don't really have a business.
The Domains of E-Opportunity
The Three E-Opportunity Domains and Their Components
The E-Operations Opportunity Initially, the e-operations applications of most organizations consisted of electronic versions of policy documents and newsletters mounted on an intranet. But the real e-operations opportunity has five potential components. (See "The Three E-Opportunity Domains and Their Components.") The Shape of the E-Operations Opportunity The first and most straightforward e-operationsopportunity component is the opportunity for automating administrative processes. Businesses are increasingly using their intranet infrastructure for the low-cost administration of "necessary evils" enrolling and training new employees, claiming travel expenses, buying pencils and the like. The improvements in cost efficiency are unlikely to have a competitive impact on cost structures. But as Cisco Systems and Schlumberger have demonstrated, such applications create a more IT-literate work force and a more nimble business culture.2 A second and more fundamental component is the new technology's ability to trigger a review of the business' primary infrastructure: its core processes and the software base that support them. Web technology may enable a new round of re-engineering of the primary infrastructure and lead to faster turnaround of customers' orders, enhanced customer support, improvements in a product's unit-cost structure and shorter time to market for new products. The third component, increased parenting value, relates to improving the performance of individual business units through help from other "members of the family."3 At BP Amoco, for example, an initiative by the center (or parent company) enables each natural-resourceexploration unit (or child) to share learning with its peers (or siblings).4 At fast-growing Regus, the company intranet is a tool for making the center's view of best operating practice available to the service staff at each office around the world. At Spotless Services, each of the catering units that
serve customers across Australasia improves their purchasing through links to groupwide contracts. The fourth component of the e-operations opportunity is intensified competitive procurement through electronic buying, such as that pioneered by General Electric. Electronic buying can mean a wider supply base, more-competitive prices and lower administrative costs. Increasingly, electronic-buying initiatives are planned at the sector level rather than the company level. An example is the General Motors/Ford/DaimlerChrysler collaboration that, by one estimate, will enable savings of more than $1,000 per car. The fifth component, supply-chain reconfiguration and integration, uses technology to enable the virtual enterprise. Companies identify the ideal network of provider partners, arrange for all selected members to have immediate access to relevant information and give the whole network the advantages of a vertically integrated business (say, focus and response speed at each point in the supply chain) without the disadvantages. Dell Computer's CEO Michael Dell believes that if his company were vertically rather than virtually integrated, it would need five times as many employees and would suffer from a "drag effect."5 Any business that operates a build-to-order strategy eventually will need to embrace supply-chain-integration concepts.
The E-Operations-Opportunity Model
Ideas That Fuel E-Marketing Opportunities
The e-operations opportunity may look familiar. Businesses have long been accustomed to evaluating the benefits of updating their infrastructure as technology changes. Supply-chain integration represents the logical, economical extension to all suppliers of the electronic-datainterchange links laboriously established with large suppliers in the 1990s. Even the parenting ideas that Regus pursues are similar to the 1980s example of Mrs. Fields Cookies, which sought to embed the operational thinking of its founder into hundreds of small retail outlets across the United States.6 But the fact that an idea is familiar does not rule out the potential for competitive advantage - particularly if technology now enables radical improvements in the implementation of the idea. For some businesses in some industry sectors, the highest priority should be investment in the components of e-operations. The question is, Which ones?
Identifying the E-Operations Opportunity The strategic significance of e-operations ideas to a particular business is a function of the role of information within that business.' Companies need to examine the role of information on three different dimensions: the information content of the product, information intensity along the supply chain, and information dispersion across the value chain. (See "The E-Operations-Opportunity Model," p. 43.) Information Content. A high level of information content in the product (found in industries such as financial services and publishing) signals the importance of reengineering the primary infrastructure of the business. An adequate infrastructure is a necessity for every company. But if information content in the product is high, the infrastructure will be central to competitive advantage: It will drive product availability, functionality and cost structure. In banking, infrastructure is a more fundamental priority than the launch of an Internet banking service. In research-based pharmaceutical companies, too, the information amassed through a product's development process dictates the primacy of infrastructure, which must support discovery, trials, regulatory submission and product-advice activities. Information Intensity. Information intensity along the supply chain points to the importance of either intensifying a company's competitive procurement or reconfiguring and integrating the supply chain. Automotive and aerospace companies are examples of enterprises with high levels of information intensity. Often they track hundreds of thousands of the components. In such industries, the availability, quality and cost of the product are dependent on the way the supply chain is managed. Businesses competing on price will probably favor the intensified-competitiveprocurement approach, whereas those stressing some form of differentiation are more likely to find advantage in supply-chain reconfiguration and integration. Information Dispersion. The opportunity for increased parenting value is greatest when there is a high level of information dispersion across the value chain - for example, when one or more of the company's activities are performed at multiple geographical locations.8 High levels of information dispersion are becoming more common as even small and midsize businesses become global. A parent -company initiative to coordinate information across replicated activities can lead to shared learning, scale economies and companywide consistency in the way an activity is performed.
The E-Marketing-Opportunity Model
The E-Marketing Opportunity Businesses differ widely in the scale and scope of their e-operations opportunity. Identifying that opportunity (or the lack of it) is the first task for the strategist, but it is not a predictor of the level of opportunity in the other domains. Even a business that rates low on all three information dimensions in the e-operations-- opportunity model may be able to change its competitive fortunes through opportunities in the e-marketing and e-service domains. The Shape of the E-Marketing Opportunity E-marketing strategy leverages new technology to get more-effective ways of selling a business's product to existing or new customers. There are three broad categories of e-marketing opportunity: * enhancing the selling process (making the sales effort more effective through better product and market targeting or by more successfully expressing the characteristics and benefits of the product); * enhancing the customer's buying experience (providing support services that make the product easier to buy or better matched to the customer's needs); and * enhancing the customer's usage experience (providing support services that increase customer satisfaction over the life cycle of product use).
Although the full potential of those e-marketing-opportunity components is as boundless as marketing creativity, many success stories share features in common. For example, the fastestsource proposition was important in the triumph of category-killer retail chains such as Toys "R" Us back in the bricks-and-mortar days, in the case of American Hospital Supply and its online links to corporate customers in the 1980s, and in the success of Amazon.com today. Each of the building blocks of marketing strategy, from customer input to a tailored-support proposition, can be improved with the help of Web technology. (See "Ideas That Fuel E-Marketing Opportunities," p. 44.) A few companies, such as Amazon and Office Depot, have embraced several marketing ideas, but most do not. The objective is not to implement as many ideas as Web technology allows but to identify and pursue the few that will bring competitive advantage to a particular company. Marketing ideas are not sector specific, nor do they come with stickers such as "for business-to-customer use only." For each idea, there may be examples relating to both business customers and consumer customers. Identifying the E-Marketing Opportunity Given that Web technology makes many new marketing initiatives technologically and economically viable, strategists must identify which particular initiatives will work for their company. A new framework can pinpoint the business and customer contexts in which a given idea is most likely to bring value to the customer and reward to the business. (See "The E-Marketing-Opportunity Model;' p. 45.) The framework relies on two constructs that are consistently powerful determinants of business and customer contexts: perceived product differentiation and frequency of purchase.9 Perceived product differentiation captures the strategic marketing context of a business. For a product with a high level of differentiation, the marketer will want to emphasize enhanced-sellingprocess ideas - those that promote the creation of distinctive products, the targeting of distribution to customers who will appreciate that distinctiveness, and the successful pre- and post-sale articulation of the benefits of the product. By contrast, providers of products perceived as having a low level of differentiation should select initiatives from the enhanced-customer-buyingexperience and the enhanced-customer-usage-experience categories to create an overall positioning distinct from the competition: "My basic product is no better/no worse than my competitor's, but I provide the customer with additional value by .... The logic of such broad prescriptions is that buyers of differentiated products will want to evaluate alternative providers carefully before making a choice, whereas buyers of undifferentiated products will be less inclined to shop around and more likely to settle quickly for an offer that matches their expectations. If a particular customer does not share the provider's view of the product's level of differentiation, however, the logic breaks down. The word "perceived" is key. Differing customer perceptions of product differentiation become the basis for market segmentation. Frequency of purchase is the other main determinant of buying behavior. Customers who are regularly in the market for a particular product have different requirements from those who are not. The lower the frequency of purchase, the more likely it is that customers will have information needs during the buying process and will respond favorably to a provider whose marketing initiatives help them navigate unfamiliar territory. However, customers who frequently purchase a product have already assimilated the necessary information and are more likely to respond to initiatives that minimize their overall transaction costs. In the frequency-of-purchase dimension, as in the perceived-differentiation dimension, the overall product market may need to be segmented, with different propositions attracting high- and low-frequency buyers. The quadrant of the e-marketing-opportunity model where high frequency of purchase meets low perceived product differentiation contains four marketing ideas, two from the enhanced-customerbuying-experience category and two from the enhanced-customer-usage-experience category. Each of the four helps reduce hassles for the customer, who is in other respects acquiring a product perceived to be no better or worse than those available from other providers. Many high-
profile dot-com "e-tailers" are operating in that quadrant, offering a standard branded product but capitalizing on the new technology's ability to extend product reach and service range. The quadrant where low-frequency of purchase meets low perceived product differentiation also contains four marketing ideas, all from the enhanced-- customer-buying-experience category, but this time related to helping the inexperienced buyer to refine choice. The public Web sites of most bricks-andmortar businesses - referred to dismissively as brochureware - represent first steps. Their importance will grow as businesses more deliberately integrate the sites into an overall clicks-and-mortar marketing strategy.10 Four marketing ideas from the enhanced-selling-process category appear in the quadrant where low frequency of purchase meets high perceived product differentiation. The ideas all relate to enriching a company's targeting in a context where customers' infrequent forays into the market must be captured and the benefits of distinctive products appreciated. As broadband access becomes the norm, the use of video will greatly increase the potential of customer input and benefit selling; the increasing availability of customer-activity information will support new ways of targeting customers. The quadrant where high frequency of purchase meets high perceived product differentiation contains just one marketing idea - achievement selling, which focuses on reinforcing the customer's choice. Achievement selling aims to prevent a regular buyer of a distinctive product from taking the product's benefits for granted. It showcases a company's track record in meeting commitments. The track record then becomes the basis for repeat purchases. At first glance, it may seem that the e-marketing-opportunity model is narrowly prescriptive, a mechanistic approach to a marketing strategy. Used as a recipe, the model will not work. Rather, it is a structure for facilitating a debate within a business's executive team. The team's first task is to agree on the business context - the quadrant that represents its product and market environment. If the team has difficulty agreeing, it needs to seek out the cause. Do team members have contrasting views on the level of perceived differentiation? Are they basing their thinking on different types of customers? What information will help resolve the different opinions to bring the team to a rich, shared picture of the e-marketing context? There are a number of reasons why a business might quite correctly conclude that it is operating in more than one quadrant. It may have customers in both high- and low-purchase-- frequency categories or customers who have contrasting views of the level of differentiation in the marketplace. More subtly, a single customer might be operating in more than one quadrant. For example, the typical customer of a popular music retailer might be a high-frequency purchaser of CDs, a medium-frequency purchaser of CDs recorded by a favorite artist and a low-frequency purchaser of a particular recording.
The E-Service-Opportunity Model
Having decided in which quadrant or quadrants the business is operating, team members can debate the potential form and effectiveness of each of the relevant marketing ideas and can decide on priorities. The highest priority will be the cases in which it is clear that new technology can actualize the relevant idea in a way that is substantially superior to the idea's current incarnation. It is pointless to offer consumers, as one U.S. manufacturer does, the opportunity to buy chewing gum over the Internet. The manufacturer may have correctly ascertained that the typical customer is a high-frequency purchaser of a low-differentiation product; but the fastest source of chewing gum for that customer will surely be the nearest corner store. Web-based initiatives in the low-perceived-differentiation and low-frequency quadrant need particular attention: Customers who are only occasional buyers may not find the Internet the most convenient vehicle for the refinement of choice unless they are regularly logged on for other purposes. Even in information-oriented industry sectors, the appropriate e-marketing initiative may be an incremental enhancement within an integrated dicks-and-mortar marketing approach. The best solution to many customers' banking needs combines Internet access for account status, ATMs for cash withdrawals, and traditional branch facilities for financial-planning discussions. The E-Service Opportunity An analysis of a company's e-marketing opportunity identifies pragmatic and incremental steps forward, just as an analysis of its e-operations does. The longer-term future - and the more imaginative leaps - can be uncovered in the e-service opportunity. The Shape of the E-Service Opportunity E-services represent the ultimate aspiration of the Information Age, with their electronic orchestration of offerings that span the breadth and lifespan
of a customer's needs within a chosen and defined market space. Although there is a gap between aspiration and achievement, a new wave of dot-com businesses and an increasing number of traditional incumbents are currently active in the e-service domain. E-service starts with a full understanding of customers' needs across a given market space, a rich and expert picture of what happens to customers in the space and what they are seeking to achieve. Synthesizing that macro understanding with data on the history and status of individual customers can allow companies to give customers advice on their specific needs. Baxter Renal has been cited as a good example of a company that redefined its business, going beyond the provision of the disposable bags required for kidney dialysis in the home to become a source of expertise in how patients can manage their lives around their treatment needs.11 E-service also requires authoritative knowledge of the products and services of all providers that might contribute in the target market space. Chemdex provides comprehensive knowledge within the biosciences arena; credible investment -advice providers do the same in their arena. An e-service business can bring together in real time the first two components of the e-service domain (understanding of customer needs; knowledge of all relevant providers) to present customers with the best choices. For example, software developed by Frictionless.com pre-evaluates options against customerspecified criteria. An e-business uses the software, then confirms that the option that meets the criteria best is indeed what the customer wants and electronically negotiates the closure of the deal. Successful examples include Priceline.com, which allows suppliers (say, airlines) to make electronic offers to meet a customer-specified price (say, $800 for a round-trip ticket from New York to Greece in August), and Mercata, which achieves lower prices by electronically aggregating a volume purchase on behalf of a group of individual customers (the more people who tell the site they want to buy a particular model of an appliance, for example, the lower everyone's price becomes).
The Sustainability Model
The e-service business stands ready to make alterations if the need arises. Suppose a customer decides that a previously arranged vacation has to be canceled because of a family illness. After a single alert, the company will cancel all bookings and submit the customer's claim for the insurance it included in the vacation package. If another customer's building project experiences an unexpected problem, the e-service business is at hand to help troubleshoot and reschedule all future materials and services in accordance with the revised plan. Visions of the perfect agent who knows your mind and acts in real time on your changing needs may sound too good to be true - and currently it is. But the e-service opportunity cannot be ignored or its identification deferred to some far-off date. Examining the scope of the opportunity can help in developing target capabilities and in setting priorities for e-operations and e-marketing strategies. CEO Jacques Nasser's service-based vision for Ford may take years to deliver, and the vision may change along the road, but it already has influenced the company's acquisition policy and its drive to make the whole work force more IT literate.12 Identifying the E-Service Opportunity To identify the e-service opportunity, a company must first define the target market space. For an already established business, the obvious starting point is the brand image and values recognized by the existing customer base. An e-service initiative for Ford will have something to do with personal transportation; for guidebook publisher Lonely Planet, it will be about personal travel. Some businesses may have a wider choice. For example, the Virgin brand name evokes a style and approach to life more than a specific product or service. Virgin has the potential to establish market-space initiatives in a number of different fields, including entertainment, the media and travel.
Next the company must decide whether the market space should be built around the customer's needs over time (for example, ongoing professional-development services) or around an event in the customer's life (for example, an everything-forgetting-married service or a corporate-roadshow service). The company should choose an arena in which it is likely to have credibility with customers. Because consideration of and insight into the customer context is the only route to selection and implementation of an e-service initiative, the appropriate framework for identifying the opportunity is the customer-service life cycle. Originally an IBM planning tool, it represents a simple intuitive structure for a discussion about the experience a customer undergoes at each of 13 stages. Understanding the customer's psychological state at each stage is critical. Unless the customer is unhappy at some point in the customer-service life cycle, it is unlikely that the opportunity for an e-service business will emerge. But at any point that the existing cycle is defective, potential for an e-service business exists. (See the exhibit "The E-Service-Opportunity Model," p. 47.) Chemdex, for instance, enters at the distribution and availability stages because up-to-date market information is problematic in the fast-changing bioscience world. Having addressed the distribution and availability for the bioscience customer, Chemdex can extend its service into the later stages of the cycle. By contrast, Kodak, with its PhotoNet initiative, identified an aspect of performance - the ability of customers to share their images with friends and relatives - as the most susceptible to improvement. For John Deere, with its DeereTrax initiative, the target is the repair stage. DeereTrax monitors equipment usage, helping farmers do timely maintenance and avoid costly unscheduled downtime. Each company successfully targets a problematic stage in the customer-service life cycle and secures two vital benefits: the customer data that will assist in extending overall e-service and the resulting customer trust. The final e-service issue is, Who needs it? The answer: all sectors. If another company (new or old) seizes an e-opportunity, it will own the customer relationship. Traditional providers will be reduced to commodity players. That is why it is so important for executives to spend time identifying what the opportunity might be. In the travel-information sector, for example, the emergence of e-service providers seems inevitable: The issue for a Lonely Planet is not whether its traditional product is replaced by online information from a service provider but when it will happen and what it will take to be successful. Determining the Sustainability of E-Opportunity Initiatives An analysis of e-opportunity is incomplete without a look at the potential for sustaining any competitive advantage gained by e-operations, e-marketing and e-service initiatives. The diagnostic model points to three potential sources of sustainability. The first and most obvious axis of sustainability, generic lead time, is a function of the technological and business changes required to implement a strategic initiative. It is tied to project analysis: How long will it take for technological and business changes to be replicated by competitors? Because applications of Web technology may be rolled out in a matter of weeks - or sourced from a specialist software supplier - companies often assume that lead time's contribution to sustainability is no longer significant. But that may not always be the case, particularly for e-operations initiatives. The upgrading of primary infrastructure may take years, not months, especially if a new generation of integrated ERP (enterprise-resource-planning) systems is required. And although supply-chain initiatives may have short technological lead times, they may well involve lengthy negotiations with numerous suppliers. The second axis of sustainability, asymmetry barriers, involves competitor analysis. If a competitor copies the planned initiative, will that cancel out any competitive advantage? Or are there barriers that preserve the advantage? For example, asymmetry barriers protected Dell
Computer from Compaq in the area of direct selling of customer-tailored PCs via the Internet. Compaq could not easily copy its arch rival's success because it had not designed its products for mass customization, and its supply-chain structures, relationships and processes were different from Dell's. The third axis of sustainability involves customer analysis. Does the customer context allow for the creation of preemption barriers, or first-mover advantage? If there is a natural monopoly for the product or service, the answer is probably yes. Consider the electronic bookstore. If customers perceive that e-bookstores provide access to all books, they will buy consistently from the first place they enroll. They won't shop around. Their familiarity with navigating the Web site and their knowledge that the e-bookstore has collected data on them that will smooth the bookbuying process - make replicating the relationship elsewhere seem daunting. Customers will stay with the first-mover company unless a competitor produces a substantially better offering that compensates for any switching costs. More commonly, the first mover retains the business unless the customer becomes seriously dissatisfied. Jeff Bezos' obsession with customer service demonstrates that Amazon.com understands the principle. In the mid-1990s, the thinking was that sustainable competitive advantage was based almost entirely on asymmetry barriers, which favored asset-rich companies. When companies such as Amazon.com and eBay grew rapidly from effectively zero-asset bases, observers began to suggest that assets were liabilities and first-mover advantage was all. In fact, all three sources of sustainability - generic lead time, asymmetry barriers and preemption barriers - are important. If Barnes & Noble is to lure loyal customers from Amazon.com, for example, it will need an integrated approach that capitalizes on its physical bookstores (its asymmetry) to offer online customers some advantages that Amazon cannot. What has changed in the analysis of sustainability is that some levers have become more available. Companies can increase barriers by protecting the intellectual property created in initiatives and by negotiating exclusivity with partner organizations (such as database owners and niche-product providers). Initiatives that organize customers into a community that adds value through mutual exchange can raise preemption barriers. Attention to the sources of sustainability - and a proactive approach to increasing them - remains a critical part of strategic development. Understanding the Domains of E-Opportunity For traditional bricks-and-mortar companies, components of e-operations and e-marketing are likely to represent immediate opportunities with real economic benefits. The e-service opportunity will usually take a longer time to realize, but charting an e-service strategy creates a strategic intent that will influence the evolution of the other two strategies." The three domains are combined within an overall approach to a business strategy that exploits the new technology. In an uncertain environment, learning from experience is critical. Few believe that we have penetrated even a fraction of the e-territory before us. The frameworks described here reveal the broad sweep of the territory, the kinds of opportunities available and how choice of direction varies according to a company's starting point. More detailed maps that might enable the strategist to identify and select the precise route to a desired destination will take time to emerge. Meanwhile, businesses must select their course and, with compass in hand, stay as close as the new territory will allow to a bearing that leads to the other side of the jungle.
ADDITIONAL RESOURCES
With so much now being published on e-business, a time-efficient way of keeping track of developments is to read the authoritative and balanced special surveys published periodically by The Economist. Those dated June 26, 1999, and Feb. 26, 2000, are still valuable.
Within the e-operations domain, insight into the role of infrastructure in competitive advantage can be found in Peter Weill and Marianne Broadbent's book Leveraging the New Infrastructure: How Market Leaders Capitalize on Information Technology" (Boston: Harvard Business School Press, 1998). E-marketing ideas can be stimulated by discussion of the scope for differentiation. Theodore Levitt's "Marketing Success Through Differentiation - of Anything" in the January-February 1980 issue of Harvard Business Review remains a classic. Another excellent discussion is contained in part two of Shiv Mathur and Alfred Kenyon's "Creating Value: Shaping Tomorrow's Business" (Oxford: ButterworthHeinemann, 1997). Some issues relevant to the e-service domain are discussed in Philip Evans and Thomas Wurster's Harvard Business Review article "Getting Real About Virtual Commerce," published in the November-December 1999 issue.
REFERENCES 1. K. Melymuka, "Ford's Driving Force," Computerworld, Aug. 30, 1999, 48-50. 2. R.L. Nolan and K. Porter, "Cisco Systems Inc.," Harvard Business School case no. 3-98-127 (Boston: Harvard Business School Publishing Corp., 2000); and A.-M. Diamant-Berger and A. Ovans, "EProcurement at Schlumberger," Harvard Business Review 78 (May-June 2000): 21-22. 3. For an introduction to the language of parenting and a full set of parenting ideas, see A. Campbell, M. Goold and M. Alexander, "Corporate Strategy: The Quest for Parenting Advantage," Harvard Business Review 73 (March-April 1995): 120-142. 4. S.E. Prokesch, "Unleashing the Power of Learning: An Interview with British Petroleum's John Browne," Harvard Business Review 75 (September-October 1997): 146-168. 5. J. Magretta, "The Power of Virtual Integration: An Interview with Dell Computer's Michael Dell," Harvard Business Review 76 (March-April 1998): 72-84. 6. J.1. Cash and K. Ostrofsky, "Mrs. Fields Cookies," Harvard Business School case no. 1-89-056 (Boston: Harvard Business School Publishing Corp., 1989). 7. For the origin of the ideas on information's role, see M.E. Porter and V.E. Millar, "How Information Gives You Competitive Advantage," Harvard Business Review 63 (July -August 1985): 149-160. 8. For a discussion of value-chain configuration concepts, see M.E. Porter, "Competition in Global Industries: A Conceptual Framework" in "Competitive Strategy in Global Industries," ed. M.E. Porter (Boston: Harvard Business School Press, 1986), 15-60. 9. For more on the effect of the first construct and the relevance of the second, see J.M. de Figueiredo, "Finding Sustainable Profitability in Electronic Commerce," Sloan Management Review 41 (summer 2000): 41-51. 10. Only 2.7% of buyers of new cars in the United States in 1999, for example, used the Internet to conclude sales, even though 40% used it as part of the purchasing process. The Economist, "Survey of ECommerce," Feb. 26, 2000, 6. 11. S. Vandermerwe, "How Increasing Value to Customers Improves Business Results," Sloan Management Review 42 (fall 2000): 27-37. 12. L. Copeland, "Ford Drives Employees to the Web To Help Connect With Online Customers," Computerworld, Feb. 3, 2000. 13. B. Ives, P.R. Rane and S.S. Sainani, "Customer Service Life Cycle," http://isds.bus.Isu.edu/cvoc/projects/csic/html/; Vandermerwe, "Increasing Value," 27-37; and D. Feeny and B. Ives, "in Search of Sustainability," Journal of Management Information Systems 7, no. 1 (summer 1990): 27-46. 14. For a definition of strategic intent, see G. Hamel and C.K. Prahalad, "Strategic Intent," Harvard Business Review 67 (May-June 1989): 63-76.
Author note David Feeny is the director of the Oxford Institute of Management at Oxford University's Templeton College. Contact him at david.feeny@templeton.oxford..ac.uk.
Playing the e -commerce game

Business and Economic Review; Columbia; Oct-Dec 2000; Varun GroverPradipkumar Ramanlal The business environment is changing dramatically with the advent of e-commerce. Even traditionally complex products like automobiles, computers, and medical services are being effectively sold on the Internet. Most would presume that consumers would benefit from the ability to search products, compare features, negotiate prices, and conduct transactions. However, it is important to note that the technology that provides consumers with shopping advantages also allows businesses to follow strategies that build monopolistic positions rather than promote free and fair competition. Gaming is an integral part of the business' survival strategy. To effectively counteract these gaming strategies, we argue that consumers must be vigilant. Digital Economics and Gaming A key attribute of the new economy is the ability to separate the information and physical components of a product or service. The Internet provides an efficient infrastructure to facilitate the delivery of the informational component. This is transforming the way consumers search and compare products, conduct transactions, and acquire and maintain products. The economics of the informational component, which we refer to as digital economics, is fundamentally different from the (traditional) economics of the physical components. This difference can be summarized as follows: Fixed costs that are dramatically higher due to human costs of developing intellectual capital (rather than plant and equipment) Marginal costs that are approaching zero, going down successively over successive generations of technological development Coordination costs that are extremely low, which not only allows ease of searching and product comparison, but also the ability to combine digital products to create new value. Furthermore, while fixed costs in the form of plant and equipment are to some extent recoverable for physical products, investments in intellectual capital in a fast-changing technological environment are often large and seldom recoverable if the business is unsuccessful. For instance, Microsoft's Office Suite requires significant developmental costs but can be replicated at virtually no cost. Windows NT with its 17 million lines of code can be replicated and distributed for under one dollar. Also, many "dot-coms" exhibit similar properties. In a competitive environment, the combination of higher fixed costs and decreasing (close to zero) marginal costs makes it increasingly difficult to survive. Furthermore, in the digital environment, technology cycles are getting shorter, and the average time to recoup investments is getting longer. As marginal costs approach zero, it becomes impossible to sustain profits and recover investments in a competitive environment. Accordingly, businesses are forced to adopt strategic practices that move them away from price competition. One way to achieve this is to adopt subtle gaming strategies that are often unapparent to the casual consumer. These "information age strategies" are new ways that businesses must learn to create competitive advantage given the impossible economics of digital costs. Watchful consumers can take the edge off these strategies.
The E-Commerce Game To see what strategies businesses can employ to sustain competitive advantage, it is helpful to understand the extremes, i.e., the market structures that businesses find least and most favorable. We then analyze how businesses, through strategic actions, may migrate from one extreme to the other. The worst-case scenario for businesses is one in which there exist considerable comparable options for the buyer, and the costs of searching and switching from one business to another are small. In such situations, buyers can easily determine the business that offers the best price for the same product and purchase from that business. To compete, businesses are forced to lower prices. Competitive equilibrium is obtained when the price is lowered all the way down to the product's marginal cost, which is the minimum price the business is willing to accept. In the case of digitized information products, this marginal cost is close to zero. In contrast, the best-case scenario for businesses is one in which products are not comparable, that business is the sole provider of the product, and/or switching costs for the buyer are prohibitively high. In this situation, the business can exert monopolistic power and price discriminate between consumers by charging the maximum price the buyer would be willing to pay. In a competitive market, buyers benefit from getting consumer surplus, defined to be equal to the difference between the maximum price that a buyer is willing to pay (i.e., the personal value a buyer assigns to the product) and the competitive market price summed across all buyers. However, in the monopolistic market with perfect price discrimination, the entire surplus accrues to the business. In other words, the business is able to charge each consumer a price equal to the maximum amount that buyer is willing to pay. It is apparent, given the digital cost structure described earlier, that businesses will be distinctively disadvantaged and will find it difficult to survive in a competitive environment that would force them to compete at marginal cost or close to a zero price for a digital product. It is our thesis that they must conceive of ways to create monopolistic power in order to capture consumer surplus. The following are some strategies they might employ. 1. Versioning Strategies A unique characteristic of digital products is the ability to sell it again and again without diminishing its value. It is also easy to create different forms of the same information. Versioning is a strategy that involves the creation of multiple versions of the same product1 that allows businesses to target different customers according to their willingness to pay. Economists refer to this as price discrimination. By doing this, competition is inherently reduced in smaller and smaller segments of the market. If buyers are targeted with a highly customized version of the product, they cannot easily compare the product across multiple suppliers or market segments. This allows the supplier (business) to price monopolistically and/or price discriminate rather than behave competitively. Versioning is a strategy that is becoming increasingly feasible with digital products for one important reason: beginning with the original product with the maximal set of features, innumerable versions can be created by simply digitally "switching" features on or off at minimal cost. By capturing customer profiles on the Web, or inferring a customer's preferences through their self-selection of products and buying behavior, businesses can modify and customize digital products aimed at the targeted audience at minimal or no additional cost.
2. Confounding Strategies Another characteristic of information technology is its ability to easily manipulate digital product information. Using IT to present information in a manner that inhibits product comparison is what we refer to as confounding. Confounding is a strategy that involves information processing used in a way that is rarely discussed - to confuse and distort. The intent is not to purposefully provide incorrect information to deceive, but rather to provide and withhold relevant information in a manner that makes it difficult for buyers to assess alternate products. The reason is straightforward. If businesses provide all available information to facilitate buyer comparison of competing products, the competitive equilibrium prevails where price is determined by cost considerations. However, if buyers cannot compare products or gain distorted or biased perceptions of price/performance tradeoffs (vis-a-vis competitors), they are forced to value products not based on cost but by the satisfaction they derive from their usage. It is this change that is the basis of comparison that businesses hope to achieve by confounding. Recall, if price is based on cost considerations, consumer surplus accrues to buyers. In contrast, if price is based on the usage value that consumers derive, then the consumer surplus accrues to business. Thus, confounding permits monopolistic pricing and/or price discrimination to occur, since it is difficult to establish competitive prices when product comparison is difficult. For instance, Reuters bundles commodity-style news items with different kinds of data services in ways that make it difficult to compare competitive products. Netflix bundles movie rentals into a monthly membership package including a number of services. This makes it very difficult for consumers to extract and compare the typical single movie rental price with those of competitors. 3. Network Effect Strategies Network effects refers to the creation of value through the existence of a large network of consumers where each consumer derives value owing to the fact that other consumers are part of the network. Positive network effects occur when adoption by one consumer creates an incentive for others to also adopt. For instance, the value of a telephone grows exponentially with the number of users that have telephones. Similarly, digital products (e.g., software) often become more valuable for buyers, the larger the customer base. Of course, the more consumers value the network, the more they are willing to pay to be part of it. For this reason, building networks of consumers (and suppliers) is a major thrust of many e-commerce businesses. Couple this with the fact the firm is the sole winner with a propriety standard, and we have the potential for windfall profits. Once the network is established, buyers may be forced to pay a non-- competitive price for the information product depending on the value they derive from the network effects. The business can raise prices without fear of losing customers so long as there is no competing product that offers similar network effects. Again, the business has broken the linkage between the price of the product and its marginal cost. Instead, price is determined by the value that consumers derive from usage of the product. Adobe built network effects by distributing its Acrobat reader software "free." This software allows consumers to exchange documents without being concerned about the software on which the documents are originally created. Once the free reader became popular and had positive network effects, it allowed Adobe to sell the writer software at a premium price. Microsoft, which recently lost its antitrust case (the decision is being appealed), prices products higher than it might if network effects were not present. Pricing can reflect the value that consumers derive not just from the use of Microsoft products but also from all the other products that run on the Microsoft platform. This pricing mechanism again delinks what customers pay for the product from its marginal cost, which is essentially zero.
4. Pricing Strategies In a classic competitive market, one business decreases price in order to draw additional customers. In response, another business may further reduce prices to achieve the same outcome. This process continues until prices are set at the minimum that businesses are willing to accept (i.e., the competitive price, where price is equal to marginal cost). This form of classic competition assumes that while one business reduces prices, all other businesses hold their prices fixed. This assumption is reasonable if information about product pricing and competitors' strategies is not readily available, so that preemptive measures based on expectation are infeasible. In that case, each business has to simply wait and observe a competitor's action before responding. In an e-commerce environment, particularly for digital products aided by IT to uncover a competitor's strategy, this assumption is overly restrictive. Pricing strategies could involve both dynamic as well as preemptive responses to changes in a competitor's prices. An astute business can stay one step ahead of its competitors by (a) being aware of the way consumers make choices on price, and (b) keeping abreast of competitive pricing moves. Using IT to implement pricing strategies can allow businesses to avoid free price competition. Some businesses wish to preempt others by learning of their pricing actions ahead of time while making every effort not to disclose their own pricing strategies. This can result in gaming between businesses using IT to selectively disclose and impede the flow of pricing information. For example, a common strategy among stock market dealers in U.S. securities markets like the New York Stock Exchange and NASDAQ is the practice of matching prices. In other words, no dealer lowers price, but all dealers agree to match the lowest price in the market. This is in effect a preemptive pricing strategy where if one dealer lowers price, then all dealers lower price simultaneously and instantaneously. The result of this preemptive behavior is subtle and onerous. It discourages any dealer from lowering price because the intended effect of drawing additional customers can never be achieved. Thus, the true price competition is avoided. The Digital Paradox The four strategies described must be enacted by businesses in order to avoid the problems of digital costs. Interestingly, if we view these strategies from a buyer's standpoint, it gives rise to a number of seemingly contradictory observations. For example, actions that buyers take that appear to be in their self-interest end up hurting them. And actions that sellers take professing to work in the interest of buyers turn out otherwise. These "paradoxes" reflect the idiosyncrasies of the e-commerce environment, where consumers often perceive they are better off, when in actuality they are not. Indeed, if consumers are not vigilant, they may unwittingly aid businesses in charging higher prices. It is commonplace now for businesses to accumulate large amounts of diverse information on consumer habits, preferences, and buying patterns. Doing so allows them to enact versioning strategies by using the low cost of manipulating digital information to create alternative versions for customer segments. What is less obvious is that highly versioned products cannot be easily compared. For instance, if Expedia (an online travel service) mines its customer data and targets a consumer with a cruise that exactly matches his or her needs (in terms of duration, type of vessel, location, and quality), it will be almost impossible for the target buyer to shop for a better price, since the market segment is one. This allows the travel service to charge more. Books.com adopted a price discrimination strategy where-- by different Internet shoppers paid different prices for the same good depending on their shopping behavior. It uses its Web design to separate price-sensitive shoppers from others, by allowing the sensitive segment to compare prices from other businesses like Amazon, Borders, and Barnes & Noble. Meanwhile, it extracts higher margins from the nonprice-sensitive segment. Similarly, Yahoo offers personalized search
engines for individual customers. These engines search and filter results based on the profile of customers captured by Yahoo (sometimes through the search process and words themselves). While the service might be valuable to the consumer, it allows Yahoo to target specific customer segments with customized products at higher prices. Similarly, by offering "free" services like personalized chat rooms for customers, Yahoo can continue to build its network effects on both the buyer and supplier side. By doing so, it can position itself to draw revenues from both suppliers and buyers. We often see "free" information and products on the Web. However, these free products could be reflective of subtle confounding strategies. For instance, a "free" search engine might be from the deeper pockets (i.e., suppliers) that sell and promote their products on the Web site. Consumers that search for "Product X" and "low price" might first screen access to the limited number of suppliers with which the search engine has contractual arrangements. This makes it a biased market since the "free" service is really directing traffic to preordained suppliers. Also, network effects that are generated by free giveaways, particularly through software products once a sufficiently large network of users has been formed, can be exploited by premium pricing on upgrades, support services, and complementary products. As the network grows, it has implications for pricing strategies since charges are not for the product per se, but for the value that consumers derive from the network. Other pricing strategies involve withholding of information. For instance, a simple example of this is the message "call for latest price" in place of a numerical price, for highly competitive products. The potential buyer, when repeatedly encountering such messages, will either call for the price (i.e., incur costs) or make a valuation judgment of the product based on the utility it offers the individual as opposed to the cost to produce the item. This shifts the pricing mechanism to one based on judgment rather than competition. Even in cases where businesses offer low price guarantees on the Web, there is no guarantee that the business offering the guarantee will get the added revenue from a sale since the next business is only one click away. In the physical world, a Wal-Mart gets the revenue from a price match since consumers incur a cost to go to the other store. In e-commerce environments it is possible for businesses to implicitly collude and adopt a pricing strategy that results in significantly higher prices than those that might be attained with free price competition. Confounding also takes place through bundling of information products - which can often be accomplished at minimal cost. Businesses prepare bundles of information products, which usually include a target product (one the consumer really wants) and some less popular or newer product (that the business wants to promote). Bundling makes it more difficult for consumers to assess the value of each product independently. Thus, if the target product is of significant value to the consumer, he/she is not likely to complain about paying a premium for the bundle, accepting the newer attached product as a free good. From the businesses' perspective, the premium received is the value extracted from the consumer for the attached product that the consumer might not have otherwise purchased. An interesting example is the airline industry. What appears to be fierce competition among large numbers of online travel agents essentially boils down to competition among a few large airlines. Even there, despite the online reservation systems, the pricing is often so convoluted (with restrictions and caveats on travel) that it is often very difficult for consumers to compare products. We would hasten to add that many of these strategies are not new, but rather become increasingly feasible in an e-commerce environment given the structure of costs in a digital economy. Furthermore, by engaging in versioning, confounding, network effects, and pricing strategies, businesses are not necessarily doing anything illegal, but attempting to survive and thrive in an environment where the conventional competition is unpalatable. Regulatory and antitrust issues might come into play when business actions (a) are predatory and involve
proactive leveraging of market power in order to drive competitors out of business, and (b) impinge on personal privacy as advocated by consumer-oriented groups. So what is a consumer to do? The paradoxes laid out above are like pitfalls that consumers should be wary of, and the four strategies that businesses employ are the means by which they lay these "traps." It is this combination of pitfalls and strategies that consumers should be aware of in all their dealings on networked environments. Best Strategy: Customer Awareness The set of prudent strategies that consumers must adopt to prevail in an information-intensive ecommerce environment, where businesses seek to avoid the competitive outcome, can be expressed in a single term: customer awareness. The imperative for awareness is higher in information markets and e-commerce environments due to the economics of digital costs and newer, powerful data-mining technologies available to businesses. Search engines such as Yahoo sell advertisements linked to search terms for a premium price. If you're a biking enthusiast searching for mountain bike trails, an advertisement might pop up for related biking gear. Customers will benefit in this equation simply because of the lower cost structures and personalization offered by information technologies. However, it is our contention that contrary to the popular press' pervasive writing on customer power, these benefits are neither imminent nor inevitable in every case. The cost structure benefits will only be derived if competitive forces are in play. To ensure this, customers need to offset the technology capitalization advantage of businesses by being aware, active, and vigilant. An informed consumer (with the time and inclination to be informed) is a powerful catalyst for market forces in any environment, but particularly in networked environments that are characterized by ease of digital manipulation. Consumers need to continually question the premium charged for customization, be reluctant to impart personal information, attempt to segregate product bundles and compare individual components, be wary of "free" products, have a propensity to shop around, try to be alert to getting overcommitted to a product, and evaluate carefully their cost/ benefit tradeoffs in purchasing decisions (e.g., marginal costs vs. marginal benefits of each additional feature on successive versions).
Aware consumers can identify and avail themselves of opportunities that facilitate competition, such as using information technology to leverage collective bargaining power and taking advantage of buyer-oriented agents (referred to as "infomediaries"2). The point is that consumers wield significant power over business strategies by actively protecting their privacy. Versioning and pricing strategies will only be possible if consumers are prepared to "sell" their information. Further, several technologies will soon permit consumers to challenge marketers for control of personal information. Tightening this control can make it much more difficult for businesses to engage in monopolistic strategies. For instance, "Cookie" technology helps companies track buyers' Web navigation patterns, while "Anonymization" software allows people to shield their identities as they surf the Web. Similarly, "Cookie" suppressors stop companies from planting information in the computers of people who access their sites, thus preventing them from identifying and tracking the behavior of those people. E-mail filters permit users to protect their computers from "spam." Anonymous payment mechanisms help people buy products and services online without revealing the purchaser's identity. Intelligent shopping agents can facilitate price comparison. We believe that in the long run there will be opportunities for customer-oriented infomediaries who will become the custodians, the agents, and the brokers of information about consumers, marketing it to businesses and giving them access to it while protecting the consumers' privacy. These new entities will draw their revenues from the buyer
side and forge brand franchises and strong relationships with customers. They will spur consumers to begin demanding value in exchange for personal data. And they will help consumers reduce the interaction cost of searching for goods at favorable prices in an environment of proliferating and increasingly complex products. The beginnings of these trends can be observed through companies like PriceLine that provide a matching between customer-specified prices and available travel deals. These companies have reduced margins of traditional travel agents by 10-20 percent. Other companies like Bizrate use information from consumers to track and rate merchants, while Verisign is emerging as the certificate authority to protect consumers from illegitimate sites. Conclusion We are in the midst of an e-commerce battleground, with three major sets of players: buyers, businesses, and regulators. All players are facing an environment of greater efficiency in the ability to process, store, and communicate information leading to higher information intensity and lower coordination costs. Businesses in the business-consumer e-commerce environment have greater IT capitalization, but face new economics of digital costs. This makes it impossible for them to compete at marginal costs approaching zero in a highly competitive environment that demands higher infusion of fixed costs. Therefore, businesses must engage in ways to reduce the competition despite an increasing buyer ability to shop and compare products. Versioning, confounding, network effects, and pricing strategies are the four ways they can leverage their IT capitalization to do this. Buyers on the other hand will be subject to these business strategies unless they are aware. This implies working to be aware, practicing active privacy, embracing new infomediaries that work in their favor, and using powerful technologies to offset business advantage. In summary, a knowledgeable and involved customer will be more successful in obtaining better trading terms in the information environment than one who is unaware and uninvolved. Regulators can intervene if business practices are predatory or they impinge on personal privacy. Hang on, the battle has just begun...
Footnote
1C. Shapiro and H. R. Varian, Information Rules (Boston: Harvard Business School Press) 1999. 2See J. Hagel and J. Singer, Net Worth (Boston: Harvard Business School Press) 1999.
Author note
Dr. Varun Grover is Professor of Management Science/Information Systems in The Darla Moore School of Business at The University of South Carolina. Dr. Pradipkumar Ramanlal is Associate Professor of Finance in the College of Business Administration at the University of Central Florida in Orlando.
Business models for Internet-based E-commerce: An anatomy

California Management Review; Berkeley; Summer 2000; B Mahadevan The growth of Internet-based businesses is truly meteoric. It has dwarfed the historical growth patterns of other sectors. Over the years, several organizations doing business through the Internet have come out with their own set of unique propositions to succeed in the business. For instance Amazon.com demonstrated how it is possible to dis-intermediate" the supply chain and create new value out of it. Companies such as Hotmail and Netscape made business sense out of providing free products and services. On the other hand, companies such as AOL and Yahoo identified new revenue streams for their businesses. Similarly companies such as Vertical Net engaged in building on-line communities. It is increasingly becoming clearer that the propositions that these organizations employed in their businesses could collectively form the building blocks of a business model for an Internet-based business.1 Several variations of these early initiatives as well as some new ones being innovated by recent Internet ventures have underscored the need for some theory-building in this area. This article develops a framework that can help practicing managers understand the notion of a business model in the Internet context. Is there a basis on which one can classify these new propositions? Are there any factors that could potentially influence an organization in identifying an appropriate sub-set of these propositions for its business? Barua et al. proposed a four-layer framework for measuring the size of the Internet economy as a whole.2 The Internet infrastructure layer addresses the issue of backbone infrastructure required for conducting business via the net. It is largely made up of telecommunication companies and other hardware manufacturers of computer and networking equipment. The Internet applications layer provides support systems for the Internet economy through a variety of software applications (ranging from web page design to security) that enable organizations to commercially exploit the backbone infrastructure. The Internet intermediary layer includes a host of companies that participate in the market making process in several ways. Finally, the Internet commerce layer covers companies that conduct business in the context provided by the other three layers. The Internet infrastructure layer and the applications layer play a crucial role in moderating and setting trends for the growth of the Internet economy. However, the notion of a business model must focus on the last two layers for two main reasons: The growth of the intermediary and the commerce layer is significantly higher than that of the other two layers. Barua and Whinston reported a 127% growth in the commerce layer during the first quarter of 1999 over the corresponding period in 1998.3 Furthermore, one in three of 3400 companies that they studied did not even exist before 1996. They also reported that 2000 new secure sites are added to the web every month indicating the creation of new companies and a migration of existing brick and mortar businesses. The extensive customer interaction in these two layers has offered more scope for creating unconventional business models and hence offers more scope for identifying certain typologies. There has been no attempt to provide a consistent definition for a business model in the Internet context. Meanwhile, consultants and practitioners have often resorted to using the term "business model" to describe a unique aspect of a particular Internet business venture. This has resulted in considerable confusion. For present purposes, the term "Internet-based e-commerce" does not include organizations that have merely set up some web sites displaying information on the products that they sell in the physical world. Only those organizations that conduct commercial transactions with their business
partners and buyers over the net (either exclusively or in addition to their brick and mortar operations) are considered. Henceforth, the term "Internet economy" is also limited by the scope of this definition. The Emerging Market Structure The Internet economy has divided the overall market space into three broad structures: portals, market makers, and product/service providers. A portal engages primarily in building a community of consumers of information about products and services. Increasingly, portals emerge as the focal points for influencing the channel traffic into web sites managed by product/service providers and other intermediaries. They primarily play the role of funneling customer attention or "eyeballs" into these web sites in a targeted fashion. Companies such as AOL and Yahoo largely cater to the business-to-customer segment. ZDNet and MarketSite.net (promoted by Commerce One) are examples of portals serving the business-to-business segment.4 The market maker is another emerging structure in the Internet market space.5 Market makers play a role similar to that of a portal in building a community of customers and/or a community of suppliers of products and services. However, they differ from portals in several ways. Market makers invariably participate in a variety of ways to facilitate the business transaction that takes place between the buyer and the supplier. Consequently, a market maker is often expected to have a high degree of domain knowledge. For instance, a portal such as Yahoo can funnel the traffic of prospective computer and software buyers into web sites that provide services related to selling these products. However, a market maker such as Beyond.com requires a higher domain knowledge related to the buying and selling of computer and software products. Also, unlike a portal, a market maker endeavors to provide value to suppliers and customers through a system of implicit or explicit guarantee of security and trust in the business transaction. Auction sites such as eBay are the early market makers in the business-to-consumer segment. Some examples of the large number of market makers evolving in the business-to-business segment include Chemdex (Chemicals), HoustonStreet.com (Electricity), FastParts (Electronic components), BizBuyer.com (small business products), and Arbinet (Telecommunication minutes and bandwidth). The business-to-business segment has several characteristics that promote a bigger role for market makers. They include huge financial transactions and a greater scope for reducing product search costs and transaction costs. Since the business-to-business e-commerce application is poised for spectacular growth, the role of market makers will be increasingly felt. The predominant forms the market makers take in business-to-business segment include organizing auctions and reverse auctions, setting up exchanges, and product and service catalogue aggregation. Product/service providers deal directly with their customers when it ultimately comes to the Internet business transaction. This calls for extensive customization of their information system and business processes to accommodate customer requirements on line. Notable examples in this category of market structure include Amazon.com and Landsend.com in the business-toconsumer segment and Cisco and Dell Computers in the business-to-business segment. These emerging market structures reveal some of the characteristics of Internet-based ecommerce business applications. First, each of these structures addresses a key constituent in the business that is carried out over the net. Secondly, they exist in both business-to-business and business-to-consumer segments (Table 1 provides a representative list of companies). Third, there is a high level of overlap and inter-dependency among the players in the three market structures. For instance, players in the product/service provider market succeed in marketing their products and services through their web site only when they catch the attention of prospective customers. In order to do this they may often need the support of a portal. Meanwhile, the revenue stream of a portal or a market maker depends to a large extent on its relationship with product/service providers. Finally, since the fundamental purpose for each of the three market
structures is very different, they have different approaches to the value that they offer to their business partners and customers and the manner in which they organize their revenue stream. Business Models for Internet-Based E-Commerce There have been few attempts to formally define and classify business models in the Internet context. Schlachter identified five possible revenue streams for a web site.6 These included subscriptions, shopping mall operations, advertising, computer services, and ancillary business. The emphasis was to show how revenue models existing in the brick and mortar scenario would be exploited in a web-based business. Fedwa identified seven revenue-generating business models.7 In addition to those identified by Schlachter, Fedwa added timed usage and sponsorship and public support as possible revenue streams. Parkinson stressed the role of business affinities such as logistic providers in creating the value proposition.8 These models were too narrow in their scope and did not cover the gamut of alternatives employed by today's Internet -based businesses. Timmers provided a broader description and identified eleven business models that currently exist and classified them on the basis of the degree of innovation and functional integration required. 9 However, these models described a particular aspect of doing business over the net and ignored other aspects. A good theory should ensure comprehensiveness.10 For instance, Timmers's example of Amazon.com for building a virtual community does not bring out another of its unique features, e.g., dis-intermediation of the supply chain.
TABLE I.
A business model is a unique blend of three streams that are critical to the business. These include the value stream for the business partners and the buyers, the revenue stream, and the logistical stream. The value stream identifies the value proposition for the buyers, sellers, and the market makers and portals in an Internet context. The revenue stream is a plan for assuring revenue generation for the business. The logistical stream addresses various issues related to the design of the supply chain for the business. Value Streams in Internet-Based Business The long-term viability of a business largely stems from the robustness of the value stream, which influences the revenue stream and the logistical stream. Figure 1 illustrates the value streams in Internet-based business. Often, buyers perceive value arising out of reduced product search cost and transaction costs. Further the inherent benefits of the "richness and reach"11 of the Internet provide an improved shopping experience and convenience. Suppliers perceive value arising out of reduced customer search costs, product promotion costs, business transaction costs, and lead time for business transactions. These benefits are likely to
be substantial in the business-to-business segment. For instance, Siebel and House reported that car dealers spend an average of $ 25 to close business with a buyer referred by autobytel.com as opposed to several hundreds of dollars in the brick and mortar operation.12 There is virtually a zero customer search cost in such referrals. The introduction of a market maker or a portal is likely to increase the value for both the suppliers and buyers, creating a virtuous cycle for all three players. As more suppliers join in the market making process, the buyers begin to see more choices. As more buyers join, the suppliers begin to experience the beneficial effects of a wider customer base and lower customer search costs. Then the buyers themselves benefit from the growing community of buyers. Finally, both the buyers and the suppliers begin to rely on the market maker/portal, ensuring a robust revenue stream for the market maker/portal. There are four possible value streams in an Internet-based business: Virtual Communities Virtual communities offer a multitude of values to the buyers, sellers, market makers, and portals. Communities have a distinctive focus that brings together people with common interests. Vertical Net is a business-to-business site that caters to 56 vertically focused communities. WebMD/Healtheon is another community site that caters to medical professionals. Community sites provide an ideal platform for the focused groups to generate value and knowledge and share it among the members. Hagel observed that it is extremely difficult to replicate the value proposition of virtual communities because much of the value of these communities is member generated.13 Moreover, communities induce a high switching cost for its members and thereby provide first mover advantage for the organizations that host these communities.
FIGURE I.
Dramatic Reduction in Transaction Costs An electronic market place is an inter-organizational information system that allows buyers, sellers, independent third parties, and multi-firm consortiums to exchange information about prices and product offerings. Moreover, the cost of product and price comparisons becomes negligible. A major impact is that they typically reduce search costs for both the buyers and the sellers. Bakos argued that as search costs come down, the prices come down both in a commodity and in a differentiated market.14 Furthermore, as more and more participate in this process, the benefits increase due to network externalities.15 Gainful Exploitation of Information Asymmetry The effects of asymmetric information on market equilibrium have been studied in a multitude of economic situations and proposed models. The models can be differentiated as search models16 and bargaining models.17 These models provide a role for intermediaries who seek to bring the price-quality combinations close to efficient informational combinations. Coupled with the effect of network externalities, the ubiquitous nature of Internet business operations has opened up new value streams that can exploit the information asymmetry that exists in many business transactions.
In situations that involve numerous buyers spread over large geographical areas and sellers who have perishable products and services it is possible to exploit the benefits of information economy into a value proposition. In the travel, hotel, and tourism industry there are a variety of product offerings and a high level of uncertainty of patronage. Since the services are perishable in nature, it is possible to buy out left-over services at a competitive price and resell them at a higher value. The sellers do not have perfect information on demand. Similarly, the buyers do not have perfect information on the supply. Therefore, an intermediary can create value arising out of this information asymmetry. Priceline.com is an example of such a value stream in a businesstoconsumer segment. Even in the case of non-perishable items, it is possible to exploit the information asymmetry by the setting up online bids and reverse auctions. In the business-to-business segment, information asymmetry often exists when there are several potential suppliers for an industrial bid. By enabling an online real-time bidding and negotiation process, it is possible to obtain substantial reductions in the final bid value. An intermediary who enables this process usually creates a value proposition and a revenue stream that is linked to the value of the reduction obtained for the buyer. Free Markets Online Inc., a Pittsburgh-based intermediary is an example of this category.18 Free Markets assists industrial buyers in posting requests for proposals and holding Internet-based reverse auctions for their products. By automating the flow of information, a pre-determined number of suppliers can be effectively included in the requests for proposal process, resulting in more competition and lower costs for the buyer. Value-Added Market-Making Process Value streams in the Internet context are sometimes augmented by additional value propositions, which can become the main value-generating stream in some cases. Security and trust, for instance, are major concerns in Internet-based e-commerce and can be used to create a value proposition. When the market maker vouchsafes the transactions that take place under its domain, it provides significant value to buyers and sellers. The seafood industry often brings small buyers and sellers together who don't know each other. By providing its trusted third-party credit rating information, Seafax imparts to buyers and sellers the confidence to trade with unknown trading partners, thereby improving the market liquidity. A similar role in the business-toconsumer segment is played by eBay. Providing financial instruments and establishing guarantees for the transactions, as well as addressing privacy and delivery reliability concerns, also have the potential for creating new value streams. Other potential value propositions include buying guides, risk management, procurement management, order fulfillment, financial instruments such as Cyber Cash, and escrow. The value streams identified above are not mutually exclusive. For instance, organizations creating a value stream on the basis of online communities can exploit the benefits of reduced transaction costs or some additional value through providing enhanced security. However, organizations often build their model on the basis of one dominant value stream. The value derived from others is incidental and supplementary to the main value stream. Revenue Streams in Internet-Based Business Value streams address the long-term sustainability of the business proposition and often set the context for identifying revenue streams for an organization. The revenue steam is nothing but the realization of the value proposition in the short term, usually on a yearly basis. In addition to the traditional modes of revenue generation, the Internet economy has allowed organizations to exploit new revenue streams that are hard to replicate in a brick and mortar operation. Following are six such revenue streams.
Increased Margins over Brick and Mortar Operations There are several factors why Internet-based businesses invariably have increased margins. As noted, the most prominent are reduced transaction costs and reduced customer search costs. Cost reduction can also be achieved through dis-intermediation of the supply chain. The classic example of dis-intermediation of the supply chain is Amazon.com's offering as much as a 50% discount on New York Times best sellers and 30% discount on other titles. The increase in margins can be further compounded by an increase in sales turnover. The cost reduction attained in this fashion is likely to be partly offset by the additional costs incurred in hosting banner ads on other sites in order to funnel customer attention into one's own web site. However, it appears that the net effect of these is an increase in margins. Revenue from Online Seller Communities By providing free membership,"9 market makers can build a community of buyers and get access to a host of information about their interests. Similarly, by promising an untapped source of buyers, market makers can also build a community of suppliers. The suppliers experience a reduction in customer search costs by entering into such markets. Once the community of suppliers and buyers are in place, the market maker can then build a revenue stream out of charging the suppliers a one-time membership fee and a variable transaction fee linked to the amount of business performed through the market maker. Advertising Many organizations look towards advertising as the main source of revenues. Portals (including the search engines) and large business-to-consumer and business-to-business community sites such as Yahoo, AOL, CommerceOne, and Agriculture Online play a crucial role in funneling the customers into the target web sites. It is natural for these web sites to host banner ads, which generate huge revenue to support their operations. Variable Pricing Strategies Organizations that sell electronically delivered products20 have unique characteristics of the information economy to exploit. High initial cost and nearly zero marginal cost characterize such information production and dissemination. Therefore, a pricing scheme based on marginal costs is not applicable for this class of products. However, it is possible to use a range of alternatives involving variable pricing and option pricing. Different consumers have different valuations for the same product, and thus have a different willingness to pay. Varian argued that if the willingness to pay is correlated to some observable characteristics of the consumers such as demographic profile, then it could be linked to the pricing strategy.21 Student and educational versions of software are examples of this category. Another strategy is the bundling of goods to sell to a market with heterogeneous willingness to pay.22 Revenue Streams Linked to Exploiting Information Asymmetry As noted, an intermediary exploiting the information asymmetry between the buyer and the supplier generates a revenue stream often linked to the amount of savings accruing to the buyer. Several variations of the auction format are being used in this area. Free Offerings The fundamental philosophy behind free services is one of giving up today's revenues in return for assured future revenues. The case of Adobe Systems giving away Acrobat Reader free
exploits this idea. As more and more users read documents with Acrobat Reader, they feel the urge to create documents using Acrobat and will eventually end up buying the full version of Acrobat. Organizations such as Hotmail and Netscape identified several other revenue streams arising out of giving out free products and services. When Hotmail provided free e-mail service, it built a huge online community of consumers waiting to be channeled into a multitude of web sites for products and services. Such a large community attracts the attention of potential sellers of products and services who are willing to pay for advertising. If the organization decides to build a community of suppliers, the suppliers will be willing to pay a membership fee and a variable transaction fee. Sometimes, the free option results in free customer feedback and product improvement initiatives. The success of Netscape browser and the Linux operating system is attributed to this phenomenon. Figure 2 demonstrates the spin-offs effects of free offerings leading to other revenue streams. Logistic Streams for Internet-Based Business The Internet economy allows an organization to position itself at an appropriate level of the supply chain depending on the nature of its business. Three distinctive logistical streams exist in the Internet economy and all three have evolved out of the need for creating the maximum value for the customers. Dis-intermediation is the process by which the logistical stream is shortened, leading to better responsiveness and lower costs. On the other hand, Internetbased business also calls for new forms of intermediation. Infomediaries and meta-mediaries seek to add value to the logistical stream by addressing certain problems arising out of information overload and transaction cost inefficiencies. Players in the product/service provider market are able to exploit the dis-intermediation stream for their business model. Portals utilize the infomediation stream and market makers utilize the meta-mediation stream. Dis-Intermediation Due to the nature of certain products and services, the Internet has made it possible to shrink the supply chain by a process of dis -intermediation. Consequently, transaction costs have been reduced and responsiveness to customer requirements has improved considerably. These improvements often lead to price reduction and/or increased margin and sales turnover. The success of Amazon.com over Barnes & Noble and that of Encarta over Encyclopedia Brittanica have adequately demonstrated the benefits of this logistical stream. In the business-to-business segment, the success of Dell Computers and Cisco is largely attributed to this phenomenon. Similarly, companies selling information databases consisting of a large number of journals in electronic form have found success by bringing down the cost of maintaining libraries. Infomediation In the market for information, the number of sources and suppliers of information as well as the amount of information is much higher than a single information seeker can handle. This is primarily due to a spectacular growth of Internet sites. Individual information seekers can not contact every possible source of information, nor can they estimate the accuracy and true value of the information offered. This has necessitated a crucial role for intermediaries to address the information requirements of users. This often involves storage and dissemination of metainformation, for example, references to information concerning a particular topic. Examples of information intermediaries offering this meta-information are primarily portals consisting of search engines and electronic product catalogue aggregators. Hagel and Rayport argue that infomediaries act as custodians, agents, and brokers of customer information and market it to businesses on customers' behalf while protecting their privacy at the same time.
FIGURE 2.
Meta-Mediation Meta-mediation is a process that goes beyond aggregating vendors and products and includes additional services required for facilitating transactions. Certain markets in the business-tobusiness segment are characterized by fragmented supply chains leading to high vendor search costs, high information search costs, high product comparison costs, and huge workflow costs. Under these conditions, meta-mediation adds value to the buyers, sellers, and the intermediary. Towards an Appropriate Business Model The alternatives presented here under each stream merely indicate the possible options available to an organization. However, the process of arriving at an appropriate business model involves choosing the right mix of alternatives. The following factors affect the choice of a business model: Role in the Market Structure-Organizations can narrow down their choices by understanding the role that they play in the Internet economy. Table 2 illustrates the alternatives available for organizations in each market structure. For instance, the logistical stream sharply divides the three market structures. Similarly, while a market maker can utilize all the four value streams, streams such as reducing transaction costs and exploiting information asymmetry are not relevant to a portal. Although the information presented in the table is a useful beginning to the process of arriving at an appropriate business model, it is abstract and at best offers broad guidelines. Within each market structure there are significant variations in the activities that
organizations perform. For example, Ethan Allen (which manufactures and sells furniture) probably cannot replicate the dis-intermediation model of Amazon.com (which sells books and music) and hope to achieve the same degree of success. Physical Attributes of the Goods Traded-Goods traded over the net can be either informational goods (soft goods, that can be transported electronically) or physical goods (hard goods that need physical transportation by a logistics provider). This influences the choice of an appropriate revenue stream. Informational goods are characterized by high initial costs to produce the first copy and almost no cost to make additional copies. This allows such firms to employ revenue streams such as variable pricing strategies, free offerings, and a combination of a one-time fee and a variable transaction-based fee. Organizations trading hard goods often have to resort to unique options that provides increased margins and/or premiums over brick and mortar operations. In the case of organizations engaged in providing a variety of services for Internetbased businesses, it is possible to employ a combination of the proposed revenue streams. The choices with respect to logistical streams are obvious for an organization trading soft goods. Such organizations eventually gravitate towards disintermediation. However, in the case of hard goods there are other factors that govern an appropriate choice of the logistical stream. Personal Involvement Required in Buying/Selling Process-The choice of the logistical stream for hard goods is significantly affected by this factor. Goods traded over the net broadly fall into two categories: experience goods and economy goods. Experience goods require greater personal involvement in the buying process. This could be in the form of making an assessment of the suitability of the buy by physically handling and examining the good to be purchased and participation in the design of the product itself by the user. Attributes such as color, texture, and the experience of using it on a test basis are crucial determinants of the buying decision in business-to-consumer markets. In the case of the business-tobusiness segment, a variety of technical specifications and joint efforts in design are sometimes important. Dis-intermediation of the supply chain is a risky strategy for such goods. On the other hand, the use of infomediaries and meta-mediaries greatly enhances the value by facilitating the process. Moreover, they can also play a significant role in reducing search costs and transaction cost inefficiencies. On the other hand, economy goods are ideal candidates for dis-intermediation. The driving force in this case is to reduce the costs by eliminating portions of the value chain that do not seem to add any value. Many MRO supplies and commodity goods traded in the business-to-business segment fall in this category. Conclusions The unprecedented growth in Internet-based business in a short period of time has underscored the need for understanding the mechanisms and theorizing the business models adopted by successful organizations. The framework presented here provides a means to understand how business models are designed for organizations in the Internet economy and allows for theory building. For instance, it is possible to develop several propositions and constructs using this framework for further empirical testing. These could relate to the market structure, the three streams, or the specifics of the business as applicable to this framework. A deeper empirical understanding of the relationship between the market structure and the choice of the business model can be investigated by specific case studies.
TABLE 2.
Footnotes
1. In this article we use terms such as "Internet-based business," "Internet-based ecommerce," and "business over the net" in an interchangeable fashion. We do not draw any distinction among them. 2. A. Barua, J. Pinnell, J. Shutter, and A.B. Whinston, "Measuring Internet Economy: An Exploratory Paper," working paper, University of Texas, Austin, July 1999; http://dsm.bus.utexas.edu/works/articles/interneteconomy.pdf 3. A. Barua and A.B. Whinston, "Measuring the Internet Economy," Cisco SystemsUniversity of Texas report, October 1999. The full report is available at http://www.intemetindicators.com 4. There is a noticeable trend among portals to evolve into the market maker structure over a period of time by partnering with some third-party service providers. Such a trend is particularly significant in the business-tobusiness segment. 5. Traditionally, a market maker takes possession of goods allowing people to buy and sell goods from it. Because it takes possession of goods, it could also take positions in these goods, thereby profiting from price movements. In the definition used here, a market maker in an Internet context does not take possession of goods. Instead, it plays the role of matchmaker and facilitates the transaction between the buyer and the seller. 6. E. Schlachter, "Generating Revenues from Websites," http://boardwatch.internet.com/mag/95/jul/bwm39.html, July 1995. 7. C.S. Fedwa, "Business Models for Internetpreneurs," http://www.gen.com/iess/articles/art4.html, 1996. 8. J. Parkinson, "Retail Models in the Connected Economy: Emerging Business Affinities," http://www.ey.com/global/gcr.nsf/us/insights eBusiness__Ernst ZT_Young_LLP, 1999. 9. R Timmers,."Business Models for Electronic Markets, Electronic Markets," Electronic Markets, 8/2 (1998): 3-8. 10. D.A. Whetten, "What Constitutes a Theoretical Contribution?" Academy of Management Review, 14/4 (1989): 490-495. 11. For a good discussion on the implications of richness and reach in Internet-based e -commerce, see PB. Evans and T.S. Wurster, "Strategy and the New Economics of Information," Harvard Business Review, 75/5
(September/October 1997): 70-82. 12. T.M. Siebel and P House, Cyber Rules (New York, NY: Currency Doubleday, 1999). 13. John Hagel III, "Net Gain: Expanding Markets through Virtual Communities," Journal of Interactive Marketing, 13/2 (1999): 55 -65. 14. J.Y. Bakos, "A Strategic Analysis of Electronic Market Places," MIS Quarterly, 15/3 (1991): 295 -310. 15. For a theoretical treatment of the topic, see M.L. Katz and C. Shapiro, "Network Externalities, Competition and Compatibility," American Economic Review, 75 (Spring 1985): 70 -83. 16. Y.M. Ioannides, "Market Allocation through Search: Equilibrium Adjustment and Price Dispersion," Journal of Economic Theory, 11 (1975): 247 -262. 17. K. Chatterjee and L. Samuelson, "Bargaining Under Incomplete Information," Operations Research, 31/5 (1983): 835-851. 18. A detailed case study on this can be found at V. Kasturi Rangan, "Free Markets Online," Journal of Interactive Marketing, 13/2 (1999): 49 -65. 19. During the early stages of adopting this aspect of the business model, organizations were charging a membership fee for the customers. However, increasingly organizations have come to realize the importance of providing free membership. 20. By electronically delivered product we mean all those that could be downloaded over the net. These include soft copies of books, electronic journals and research reports, software, music, and games. 21. H.R. Varian, "Pricing Information Goods," working paper, University of California, Berkeley, in Proceedings of the Research Libraries Group Symposium on "Scholarship in the New Information Environment," Harvard Law School, May 2-3, 1995. 22. See, for example, H.R. Varian, "Versioning Information Goods," working paper, University of California, Berkeley, 1997. 23. John Hagel III and J.F. Rayport, "The Coming Battle for Customer Information," Harvard Business Review, 75/1 (January/February 1997): 53-65.
Author note
This research is partly supported by the Center for Asia and the Emerging Economies at the Amos Tuck School of Business Administration, Dartmouth College.
Hybrid retail: Integrating e -commerce and physical stores

Industrial Management; Norcross; Sep/Oct 2000; Reuven LevaryRichar G Mathieu Truths once held to be self-evident are being challenged as traditional bricks-and-mortar retail stores implement ecommerce strategies to compete with pure e-retail companies. Traditional wisdom assumes that Web-based retail is a threat to long-established retailers such as Wal-Mart, Home Depot and Sears. The logic is that these national retail chains are burdened with an expensive network of physical stores that are supplied through a costly, complex distribution network. Recently Jeff Bezos, founder and CEO of Amazon.com, flatly stated that pure Webbased retail would always offer the consumer a greater selection of products at lower prices than traditional retail stores. Is this true? A closer look at the factors that drive Web-based sales indicates that many of the attributes enjoyed by traditional physical retail stores may actually prove advantageous for online retail success. Physical retail is considered first-generation retail. The second generation of retail selling began with the advent of electronic retail (e-retail). Universal, 24-hour-aday access to a centralized order processing and distribution system is the hallmark of e-retail. A well-designed Web site provides the customer greater ease and speed in access, shopping, and buying than physical stores do. In addition, Web technology allows companies to personalize the shopping experience by guiding the consumer to parts of the site that are in line with the customer's interest profile. The process of online buying allows the business to create a consistent, personalized, and efficient shopping experience. In addition, the automated and centralized business processes of e-retail allow for a wide variety of highly discounted products. Amazon.com, one of the leaders in e-retail, continually receives high marks for customer service. Their Web site is designed to speed the consumer through the process of selecting and ordering books, music, videos, toys, electronics, and home improvement tools, while giving reassuring, personal service at highly discounted prices. Products are typically drop-shipped using delivery services such as UPS and FedEx. The combination of efficiency, discounted prices, and personal service is why Amazon.com is frequently mentioned as a model of customer service for businesses on the Web. Traditional retail companies have tried with varying degrees of success to compete with the eretailers. Even though its Web site has yet to make a significant contribution to its total revenue, retail giant Wal-Mart has publicly stated its intention to stake a leadership position in e-commerce. At Office Depot, Bill Seltzer, executive vice president and chief information officer, spends nearly one-third of his time planning and initiating an electronic-business strategy. Sales through Office Depot's enhanced Web sites totaled $219 million for the first three quarters of 1999 and rose more than 492 percent from the previous year, according to an article by C. Wilder published in InformationWeek. Yet Web sales account for just three percent of the company's total annual revenue. Even less aggressive retailers admit that the potential for synergy between physical stores and e-retail exists. For example, Rangnar Nilsson, chief information officer for Karstadt (Europe's largest department store chain), was quoted in Harvard Business Review as saying that he believes "e-commerce can be a true extension of shopping in the physical world, but not all stores are currently in a position to take advantage of it." In many ways the retail industry is trailing other sectors of the economy in e-commerce. For example, in a December 1999 survey of 375 businesses and information technology managers, businesses in the retail sector estimated that 7 percent of their company's total revenue came from their Web site, 10 percent of Web site visitors buy online, and only 31 percent route ebusiness customer inquiries to a customer relationship database. This compares unfavorably to the IT and financial services (FS) sectors, where 18 percent (IT) and nine percent (FS) of revenues are Web-based, where 10 percent (IT) and 23 percent (FS) of Web visitors buy products online, and where 58 percent (IT) and 42 percent (FS) of businesses deploy customerReproduced with permission of the copyright owner. Further reproduction or distribution is prohibited without permission.
relationship databases. Yet, in spite of these numbers, more than 61 percent of all retail organizations either currently have or have planned a Web-only business division. Clearly, there are high expectations among retail businesses with regard to e-commerce. The third generation of retail will be characterized by hybrid organizations that combine the best of e-retail with the best of traditional bricks-and-mortar retailing. According to the Harvard Business Review article, prognosticators such as John Quelch, dean of the London Business School, believe that hybrid retail, may work "for supermarkets, wholesale clubs, and retailers that offer a great assortment of mostly low-end merchandise." Others see a broader role for hybrid retail, in which retailers of products that buyers must see in person before they buy view their physical stores as the key channel for acquiring and building relationships with customers and where Web sites are set up as fulfillment channels, organized to handle repeat orders at a low cost. The purpose of this article is to compare and contrast physical retail, e-retail, and hybrid retail across a variety of dimensions. These dimensions are based on a model of a retail system that considers both the customer's purchasing experience and the retailer's fulfillment processes. The results of this analysis are used to explain current developments and forecast future developments in how retail businesses adapt to e-commerce. Traditional catalog retail is actually an offline version of e-- retail. Most catalog retailers have established or are in the process of establishing an e-retail component of their business. This makes their business model identical to or very similar to that of e-retail. For this reason, catalog retail is a unique retail category Model of a retail system In order to evaluate the three types of retail systems, we must look at a model of a retail system. The model shows the measures of system success that come from the customer's purchasing experience and from the retailer's fulfillment process. The model begins with the assumption that market share and profitability ultimately determine the success of a retailer. Market share is determined by a retailer's ability to attract new customers and retain existing customers; thus, the need to examine the customer's purchasing experience. Profitability is affected by profit margin and sales volume; thus, the need to examine the components of the retailers operations. The model is represented in a schematic form in Figure 1. Customer total satisfaction with the purchasing experience is defined as customer satisfaction with the purchasing experience during all three phases of the purchasing process (i.e., prepurchasing, purchasing, and post-purchasing). Customer total satisfaction with the purchasing experience affects retailer ability to attract new customers and retain existing customers. A retailer can gather valuable information regarding customer satisfaction during the purchasing process, including components of customer satisfaction throughout the phases of the purchasing process. For example, the number of customers who purchased one or more products compared to the number of potential customers (i.e., those who browse a retailer Web site or its physical aisles) is one indication of retailer effectiveness in achieving customer satisfaction with the prepurchasing experience. The number of repeat customers compared to the total number of customers as well as information regarding the frequency of repeat purchases are additional indications of the retailer effectiveness in achieving customer satisfaction with the purchasing experience. The percentage of retained customers among those customers who have returned purchased items is an indication of the retailer effectiveness in achieving customer satisfaction with the post-purchasing experience.
The information a retailer gathers regarding customer satisfaction with the purchasing process can be used to plan marketing policies for each of the three phases of the process. Implementing specific marketing policies may increase customer total satisfaction with the purchasing experience but may reduce profit margin because of the cost associated with implementing such policies. For example, stores that have frequent large promotions to attract customers may end up selling larger amounts of products for a smaller profit margin. Similarly, retailers that increase the number of sales associates and customer service representatives or maintain a no-hassle return policy may attract more customers but end up reducing the profit margin. The effectiveness of the information system that coordinates and integrates its supply chain affects a retailers ability to ship products efficiently from suppliers to customers via the retailer's distribution system. The efficiency of a supply chain is determined both by the level of inventories kept at distribution centers and stores as well as by the retailer's cycle time. A retailer's cycle time is defined as the time that elapses between ordering products from suppliers and delivering them to retailer's customers. The level of efficiency of a retailer's supply chain affects its profit margin. The level of coordination of a retailer's supply chain with its various marketing policies and with real-time point-of-sales information affects a retailer's ability to offer customers the products they want, when and where they want them. This ability affects a retailer's effectiveness and, ultimately, its profit margin. Criteria used to evaluate the different retail systems are defined in the next section. These criteria, used in conjunction with the aforementioned model of a retail system, make it possible to identify the most effective retail system. Physical retail, e-retail, and hybrid sales systems are evaluated below according to a variety of criteria. The criteria are compiled into two groups. The first group of criteria is related to the customer's experience with the purchasing process and is evaluated in Figure 2. The second group of criteria is related to retailer advantage and is evaluated in Figure 3. Comparison from the customer's view In Figure 1, the criteria are grouped according to their phase in the purchasing process. The first criterion considered in the customer's pre-purchasing experience is the spectrum of products offered. Physical retail offers a much narrower spectrum than e-- retail because cost is prohibitive. E-retailers are able to build warehouses in remote areas where land is cheap because they need not draw customers to their physical location. Physical retailers, to the contrary, must pick sites that are easily accessible and zoned for consumer traffic. Such sites are limited and, as a result, cost more and are often linked with higher taxes. Since the presentation of products makes for customer appeal, physical retailers actually use more space per item than e-retailers. Displays must be eye-catching and allow room for customers to move about the store. The same number of products will necessitate more space for a physical retailer than for an e-retailer and, as a consequence, result in greater inventory cost per item. Thus, the physical retailer has fewer items available than the e-retailer because space is either unavailable or not affordable. Since the hybrid retailer has an e-retail component, it can offer the same wide spectrum of products as the e-retailer and thus shares that advantage.
The second criterion considered in Figure 1 is information related to product availability E-retail has the potential to provide comprehensive information to the customer online. Physical retail, on the other hand, has only limited information available to the customer. This information is accessible via brochures, ads, etc. Hybrid retail, with its e-retail component, shares the competitive advantage with e-retail regarding information on product availability. If, however, the hybrid retailer makes online information regarding product availability in the physical store available to customers as well, the hybrid may increase the effectiveness of its physical store component. A kiosk in a physical store that provides online information regarding product availability will likely improve the physical store's advantage. The advantage will be limited, however, because customers must come to the store to get the information and will likely have to wait in line to access it. Since information systems that are easily navigated and provide information on product availability along with appealing graphics would typically necessitate costly upgrading from existing systems, some physical retailers would find them too expensive.
Retail stores typically offer incomplete lines of particular products. A shoe store, for example, might sell a certain shoe in narrow and medium widths only. Retail stores also often sell only selected brands of merchandise. Since retail stores must sell what they carry, they are unlikely to provide information about the full range of competitive products. Because e-retail is not constrained by space limitations or regional tastes, e-retail can sell and provide information about the whole spectrum of products. Furthermore, there is no salesperson to push particular items. Instead, e-retail customers read available information from independent sources that may be provided online, such as Consumer Reports, and then make an independent evaluation according to personal need. Thus, the completeness of information criterion listed in Figure 2 ranks e-retail and hybrid as high and physical retail as low. On the criterion of completeness of information regarding availability of sales merchandise, retail stores rank low. Sale flyers advertise a range of discounts (e.g., 20 percent to 25 percent off) on a range of products (e.g., many name-brand suits). Product availability varies with the store, as sales merchandise is often that which remains from a current product line at the end of a season. Thus, a customer knowing the general parameters of a sale goes to his local department store to find that only three brands of suits are on sale and all available are sized extra large. E-retail lists specific items along with specific sale pricing and thus ranks high for completeness of information on sales merchandise. Hybrid retail ranks high as well due to its e-retail component. If hybrid retail provides information online about sale items in their physical stores and allows the potential customer to both access this information and reserve a particular item at a nearby store for immediate pick-up, the hybrid retail offers a customer advantage.
Customers at physical retail stores are constrained by store hours. Customers at e-retail and hybrid retail, however, can make purchases any time. Further, with portable computers, they can purchase from any location. Even customers who are out of town can purchase from a favorite Web site. Customers at physical retail stores must be near the store of choice. E-retail is less advantageous when one considers ease of product retrieval. Consumers at physical stores and at those hybrids where customers are allowed to pick up e-ordered merchandise at a physical store are able to obtain products in the most timely manner. There is no delay for shipping and handling. When time is critical, consumers are most likely to frequent the type of store that allows for immediate pick-up. This gives customers at physical retail and the specified hybrids a time advantage. Physical retail and hybrids complement this advantage with an expense advantage. Consumers who pick up items save on shipping and handling costs. The lower the total purchase price, the higher the contribution of shipping/handling cost to overall price and the less appealing the product. This criterion is related to both the pre-purchasing and purchasing experience. The ability to communicate with a live person regarding product characteristics is the first of the criteria related to the customer's experience during the purchasing process. While salespeople in a retail store do not typically offer complete product information, they do offer some advantages. A good salesperson can often offer useful insights gleaned from experience. For example, while sales personnel in a camping goods store may not be able to offer information on a brand of product not carried in the store, they might be able to tell you whether such a product in general is worth its weight when backpacking in Canada. Salespeople who know their merchandise are also often helpful in matching products to customer needs. In e-retail, for example, it may be difficult to determine exact color or fit of clothing. A salesperson, however, can look at a pair of pants that a customer is wearing and suggest specific sweaters that might be coordinated with them, thereby saving time and confusion. Many customers value the personal warmth as well as the expertise of a salesperson. For many people, the smile accompanying a sales associate's comment that "tapered legs are flattering on you" makes her invaluable. Retail stores and hybrids rank high for ability to communicate with a live person regarding product characteristics. E-retail stores that offer e-mail or phone communication with a live person rank in the middle. While such communication may not be as effective as communication with a salesperson who can see both the customer and the merchandise, it is better than no communication at all. Another criterion related to the customer experience during the purchasing process is the ability to shop with a remote friend. E-retailers and hybrids offer consumers one opportunity that physical retail stores cannot. E-retail and hybrids allow consumers who are separated by large physical distances to shop together. By browsing together online at the same e-- retail Web site while chatting simultaneously on the phone, Mom in St. Louis and Grandma in Phoenix can pick out a gift for Suzy in Los Angeles. The return policy pertains to the post-purchasing experience. Returning items to a physical store is an easy task. The customer goes to the store with the merchandise and is helped by a salesperson or manager. Returning items to hybrid retail is equally easy if the hybrid allows the ecustomer to return items to a physical store. Returning to an e-retail store, however, is more complex. The customer may or may not have to contact the company via e-mail first. Then the customer must deal with re-packaging the merchandise before taking it to the post office or engaging a delivery service. Customers may have to pay for shipping and insurance and may later have to seek reimbursement. Comparison from the retailer's view The criteria outlined in Figure 3 are those dealing with retailer advantage with respect to effectiveness of marketing policies, information system, and supply chain. The first criterion
related to marketing policy is the ability to hold regional sales. Retail stores and hybrids garner the advantage in sales flexibility. Both are able to hold regional sales as needed to promote purchase of slow-moving inventory Product sales vary according to locale. The season for winter merchandise, for example, might be shorter in the Midwest than in the North, so sales on winter apparel might begin earlier in Missouri than in Minnesota. E-retailers, however, cannot hold smallscale regional sales. When competing with regional sales, e-retailers must offer nation-wide reductions. This means that e-retailers must lower product costs unnecessarily in certain regions if they are to compete with retail stores. If they choose not to compete with regional sales in a timely manner, they must absorb inventory costs until a national sale is productive. Thus, eretailers lack the sales flexibility that retail stores and hybrids enjoy. E-retailers lose in more ways than one when retail stores and hybrids offer regional sales. Customers who are lured inside a physical store for a sale may be tempted to buy multiple items. Customers may buy items that are attractively displayed or they may be reminded of items they need once walking through the aisles. Impulse shopping is anticipated from physical retail customers. Many people wander through malls as a form of entertainment. They socialize with friends and pass time while browsing. While e-customers may also do some impulse shopping as they browse online through pictured items, they are probably less apt to do so because pictured objects are somehow less engaging than physical ones. Hybrid retailers who allow customers to pick up and return items at a physical store may have the ultimate advantage of tempting impulse buyers. Customers who may not be tempted to make additional purchases online will have a second opportunity to buy on impulse once they are in a physical store to pick up an electronically ordered item. There they will be lured by the physical displays of merchandise. E-retailers and hybrid retailers must price items for national distribution. They must often disregard regional market differences if they are to compete nationally Although an item might bring in a higher price in one section of the country than another because of customer demand, the e-retailer and hybrid retailer must consider all markets when establishing a single price. If the e-retail price is too high for some geographic areas, the retailer may sacrifice customers. If the e-retail price is too low for some geographic regions, the retailer may sacrifice profit margin. Hybrid stores are in a unique position. To attract e-customers, they must choose a competitive price for electronically ordered merchandise. If the same merchandise is sold in the hybrid's physical store, however, the price must reflect local market value. The hybrid retailer will lose profit margin at the physical store if it sells the item at the e-retail price. It may lose customers at the physical store, however, if the e-retail price is considerably lower than the price at the physical store. Hybrid stores have a complex pricing issue because they are in the unenviable position of competing with themselves as well as with physical and e-retail competitors. Companies are able to collect information regarding customer buying patterns effectively when customers shop online. As online transactions are recorded, information regarding customers and the products they choose becomes available. Customers in physical stores may refuse to provide personal information such as address and phone number. For this reason, e-retail and hybrid stores have the advantage over physical retailers of being able to collect more complete information regarding customer buying patterns. E-retail and hybrids can use collected information to tailor their marketing efforts to better match the needs and tastes of customers. Buying patterns and interests of e-customers can be incorporated into the expert systems of eretailers so that Web sites can be personalized to suggest products a customer may desire. In other words, once the expert system analyses data regarding the past buying patterns of a particular customer and compares it with the buying patterns of other customers with similar interests, it can suggest other products that may suit the customer's interests. Amazon.com has such a system. The company analyzes the characteristics of books a customer buys and then suggests other books that may be of interest. This marketing capability can increase sales for eretailers and hybrids.
E-retailers' computer and information systems, which enable the retailer to conduct virtually all business transactions online, are more complex than those of physical retailers. Hybrid retailers that allow e-customers to pick up and return products at physical stores must be able to trace and coordinate the movement of materials, orders, and financial transactions among the components of their e-business and their physical stores. This necessitates an even more complex computer and information system. The ability of a hybrid retailer to allow e-customers to obtain information online regarding sale items at physical stores and to allow those customers to reserve merchandise in physical stores requires a still higher degree of complexity of computer and information systems. The more complex the computer and information system, the more costly the installation and maintenance of such systems. For this reason, physical retailers that require a less complex system than e-retailers and hybrids have an advantage. Criteria dealing with a retailer's supply chain include the ability to take advantage of electronic data interface technology and quantity discounts for purchasing from suppliers as well as discounts for shipping costs. EDI technology requires the transmitted data to be set in a standardized format that has been agreed upon by a retailer and its suppliers. All the application software involved in generating the required data must be compatible. This requires a high degree of cooperation and coordination among retailer and suppliers. Such cooperation and coordination is justified only between a retailer and its high-volume suppliers. Since e-retail and hybrid are both dealing with large purchasing volume for a wide range of products, they can take advantage of EDI technology more than physical retailers that have a much smaller range of highvolume products. E-retail and hybrid stores purchase large volumes of a wide range of products from suppliers. This puts them in a much better bargaining position for quantity discounts than physical retailers. Furthermore, e-retail and hybrid companies are also in good bargaining position when negotiating transportation costs for shipping a high volume of purchased products from suppliers to the stores' warehouses. These cost savings give e-- retailers and hybrid retailers a competitive advantage over the physical retailer. The criteria related to customer experience with the purchasing process, summarized in Figure 2, indicate that e-- retailers may be able to achieve competitive advantage with regard to: spectrum of products offered information about product availability completeness of information about competing products completeness of information regarding availability of sale merchandise customer ability to purchase products from any location at any time customer ability to shop with remote friends physical retailers may achieve competitive advantage over e-- retailers with regard to: timeliness and cost of product retrieval ability to communicate with a live person about product characteristics effectiveness of return policies
The criteria related to retailer advantage, summarized in Figure 3, indicate that e-retailers may achieve competitive advantage over physical retailers with regard to: completeness of information about customer buying patterns ability to take advantage of EDI technology ability to take advantage of quantity discounts for purchasing and shipping costs from suppliers Physical retailers may achieve competitive advantage over e-- retailers with regard to: ability to hold regional sales potential gain in business from impulse shopping
complexity of computer and information systems
This evaluation concludes that e-retailers have a competitive advantage over physical retailers based on some criteria while physical retailers have competitive advantage over e-retailers based on other criteria. Hybrid retailers who have both e-retail and physical store components can benefit from the advantages of both. With effective coordination and integration of the two components, hybrid retailers can achieve competitive advantage over both e-retailers and physical retailers. Not only do they garner the advantages of both individual components, they can provide customers with a higher degree of flexibility than either e-retailers or physical retailers. Hybrid retailers can allow their e-customers: obtain online information regarding product availability in physical stores obtain online information regarding sale items at physical stores reserve merchandise in physical stores online pick up and return items ordered online at physical stores These options can provide customers a degree of flexibility and convenience that may give hybrid stores the competitive advantage over both e-retailers and physical retailers.
Doing all this, however, requires a high degree of coordination, as the components of physical retail and e-retail must be integrated. Hybrid retailers must employ more complex computer and information systems than either physical retailers or e-retailers do. This is costly and complicated and might well be considered a disadvantage of the hybrid system. The only other disadvantage hybrid retailers face is that they must deal with the impact of a price differential between products sold in different geographical regions. Hybrid retailers must simultaneously compete locally and nationally on prices. These two limitations of hybrids may be easily outweighed by the many advantages. Conclusions Hybrid retailers enjoy several distinct competitive advantages in the marketplace. The efficiencies offered by Web-based technologies combined with the effectiveness in customer relationship management offered by physical stores suggest the emergence of a third generation of retail. Today, consumers are increasingly using both online and physical stores in the purchase process. For example, The Retail Power Shift by S. Morisette, K. Clemmer, and WM. Bluestein indicates that 31 percent of online consumers use the Internet to research goods that they buy in physical retail stores. In addition, customers are willing to change their point of purchase once they have established a brand or product loyalty. For example, online customers say that they are significantly more likely to repurchase products from their online merchants than from traditional retailers. Major retailers are adapting their strategies to meet the needs of third-generation retail. Home Depot has promised a Web site that will be able to check store inventory online and will facilitate online product ordering with the option of home product delivery or store pick-up. Wal-Mart may take advantage of its 2,500-unit nationwide store base by creating drivethrough pick-up stations to allow online customers to collect their orders immediately from their neighborhood store. In Japan, online merchants deliver merchandise to local 7-Eleven stores, where customers can pay cash for the items received. Finally, Radio Shack is allowing online customers to return items to any one of 5,000 local Radio Shack retail locations. In spite of these major developments in the retail sector, it is unclear whether any of these retail giants have developed a cohesive strategy for integrating e-retail with existing physical stores. For example, there has been little discussion about how the physical retail stores themselves will need to change. It has been suggested that for some retailers, the physical store will become a
low-square-footage showroom where a majority of product inventory is shipped from regional fulfillment centers. Others see Web-enabled kiosks providing customers with help finding items in the store, allowing customers to order items not in stock, and providing detailed product information. Still others see stores with electronic shelf labels and signage allowing retailers to change prices and promotions dynamically in response to customer demand, competitive conditions, and product perishability The sheer size of many retail chains may prove important in terms of brand awareness and scale economies. Yet none of these strategies will be successful without a tightly integrated fulfillment process that combines the best of e-retail with the best of the physical store. Traditional bricks-and-mortar retailers are not the only retailers to face change. E-retailers must develop specific strategies to meet the needs of their customers. Often this will require the presence of physical stores. Just as computer retailers such as Dell and Gateway have developed a network of third-party businesses to service their products, other retailers will seek to establish relationships with local companies to facilitate product pick-up, servicing, and return. In an effort to service their customers better, some e-retailers have begun establishing a network of physical stores (e.g., Gateway Computers). In addition, traditional catalog companies such as Lands End and Eddie Bauer have expanded their operations to include e-retail. Two fundamental pieces are required for business success in third-generation retail: a wellfocused strategic vision and well-integrated information architecture. Businesses must develop strategies that balance the advantages of a physical store presence with the efficiencies offered by Web-based retail technologies. These business strategies must take into account the customer's satisfaction with the overall purchasing experience and should seek methods to attract new customers and retain existing customers. Finally, businesses must build a flexible information architecture that facilitates the retailers marketing and supply chain logistics, as well as the actual purchasing process. For hybrid organizations, this requires a high degree of coordination, as the information components of physical retail and e-retail must be integrated. Ills
Reference
Evans, P and Wurster, IS,, "Getting Real About Virtual Commerce," Harvard Business Review, Nov]Dec. 1999. Gallaugher, J., "Challenging the New Conventional Wisdom of Net Commerce Strategies" Communications of the ACM, July 1999. Landry, J.T., "Electronic Commerce: A New Take on Web Shopping," Harvard Business Review, July/Aug. 1998. Maruca, Rr-, R"Retailing: Confronting the Challenges That Face Bricks -and-Mortar Stores," Harvard Business Review, July/Aug. 1999. Morrisette, S., Clemmer, K., and Bluestein, WM., The Ret Power Shift, Forrester Research Inc., 1998. Wilder, C., "Retail Turns to Click and Mortar," InformationWeek, Sept. 27,1999. Wilder, C., "The Fast Track to Becoming an E-Business," InformationWeek, Dec. 13, 1999.
Author note
Reuven R. Levary is professor of decision sciences at St. Louis University. He received a Ph.D. in operations research from Case Western Reserve University and is co -author of Quantitative Methods for Capital Budgeting and editor of Engineering Design: Better Results Through Operations Research Methods. His articles have been published in a variety of professional journals. Levary serves on the editorial boards of several journals; he is a fellow of AAAS and a member of INFORMS, IEEE, and the Society for Computer Simulation. Richard G. Mathieu is an associate professor of management information systems at St. Louis University in St. Louis, Mo. He is on the faculty advisory committee for the graduate program in operations and supply chain management in the School of Business and Administration at St. Louis University. He received his Ph.D. and M.S. from the University of Virginia and his B.S. from the University of Delaware.
A lesson in strategy: Case study 1
Hospitals & Health Networks ; Chicago; Dec 2000; Lee Ann Runy Like Minnesota's early settlers, Allina Health System in Minneapolis embodies the pioneer spirit. In the rnid-1990s the health system, which owns and operates 19 hospitals in Minnesota and Wisconsin, thrust its stake in the Internet frontier. Although Allina was one of the early adapters of Internet use in health care, its philosophical approach remains unique. Rather than adopt a specific e-health or e-business strategy, it eenabled the business strategy already in place, examining operations to determine where the Internet could create the most value. It found that the most effective use of the Internet would be in decreasing administrative overhead, changing how patients are managed and generating new revenue sources. Allina took pains from the onset to avoid quick-fix, short-term solutions, says David Pryor, M.D., senior vice president of system health services and chief information officer. It examined its business competencies and identified several opportunities for long-term improvements. First, Allina tackled operational efficiencies, which required significant investment in its IT infrastructure. It increased its bandwidth six-fold, resulting in a 99.9 percent network reliability rate. Through continued upgrades, the network eventually will be able to handle the telephone system and establish five-digit dialing across the organization. Allina invested $500,000 in its intranet, Pryor says. As a result, the organization is realizing savings of about $2 million a year. The intranet now maintains a wealth of resources, consisting of more than 70,000 pages of information, including the organizations policies and procedures, a systemwide telephone directory that is updated weekly, and limited access to Allina's data warehouse. Allina has virtually eliminated all paper man- A uals and directories, and Pryor says the intranet will probably be expanded to handle travel expense sheets and other administrative forms. In addition to financial rewards, Pryor says that the IT investments resulted in some unexpected benefits. The system's 8,000 desktop workstations are now centrally managed. And, calls to the system's help desk decreased by 30 percent. Allina also gained operational efficiency by moving its materials management system online. Pryor says the move resulted in a "huge win" for the system, achieving about $10 million in savings by standardizing the process, and additional savings will come from direct purchasing. Allina has partnered with St. Paul, Minn.-based Lawson Software to handle its materials management processes. Physician decision-making was the second business competency Allina sought to streamline and improve through the Internet Allina has about 700 physicians on staff at its 19 hospitals, six nursing homes and 48 clinics. It also has relationships with hundreds of other physicians. Those two groups of doctors had to be addressed separately, Pryor says. The salaried physicians employed by Allina were given complete access to the Allina network and its electronic medical record system, which includes a patients complete medical record, detailed lab results and other information, such as allergies and medications, to assist physicians in the decisionmaking process.
The efficiencies realized through the EMR system are many, but did not come without some resistance. Allina relied upon staff opinion leaders to help colleagues see the benefits. When physicians began to realize the efficiencies EMR would create in their practice-including reductions in chart pulls and dictation-many began to volunteer to learn the program on their own time, Pryor says. Other benefits of EMR include the ability to access patient records at all points of care throughout the Allina system and improved physician and patient satisfaction. Pryor says temporary loss of physician productivity was a potential risk of moving to EMR but Allina did not experience any significant problems. One of the biggest challenges Allina faced concerned its affiliated and contracted physicians, particularly what information should be provided to them and in what format That group wants to remain independent and maintain total control of its practices, but needed to access patient information in a timely, efficient and secure way. To achieve that, Allina partnered with Minneapolis-based Abaton.com, now part of McKesson, a developer of Web-based clinical applications. Allina's affiliated and contracted physiclans can log on to a secure site from any location and order laboratory tests, check benefit eligibility and receive test results. The Web-based system helps improve clinical workflow, eliminates the paper trail and helps physicians make timely, informed care decisions. A third element Allina addressed was informed decision-making by patients. Allina provides support to is patients at home through three Web sites: Allina.com provides detailed information about all of Allina's hospitals and clinics and the Allina Health System Foundation. Among other things, users can access directions, parking and transportation information, job openings, lists of services provided, classes, and volunteer opportunities. Medformation.com is designed to support the health care consumer. Its "Find a Doctor" feature lets patients search for physicians by specialty, location, gender and languages spoken. Once physicians are identified, patients can access the physician's Web site, if available, and view office hours, locations and types of insurance accepted. It also provides a list of every physician's credentials, including years of practice and where the physician attended medical school and completed his or her residency, internship and fellowships. Consumers also can access daily national and local health news and tips and sign up for "eMagazines," weekly updates that provide information and health tips for specific dis eases and conditions. Medformation.com receives its national news feed from Reuters Health and has its own writers and editors to report on local news. Pryor says it's important to remember that health care is local and should maintain a community feel. The site also provides several chat room options. Medformation.com generates revenue through ad sales, but ads are clearly identified as such. One important aspect of the site is that patients can sign up and maintain a personal medical record, which they can share with their physician to show the results of care at home. Pryor says the goal is to enhance the physician-patient relationship by allowing more interaction. It has received positive responses from patients and physicians. The third site is Medica.com. Medica is Allina's health plan, serving more than 10,000 employers. Pryor says about 30 percent of Allina patients are Allina insurance members. Medica.com provides information about Medica products. A members-only section provides health and well ness resources and benefits information. Providers can access Medica!s medical policies and clinical guidelines, provider network operations, contracting and coding information, and Medica's drug formulary.
Pryor says Allina's Internet efforts have been effective and well received. He cautions an organization considering such a move to take a close look at its own culture before making any significant decisions. Health care organizations, he says, are generally conservative, reluctant to change and to take chances. He added that the not-for-profit culture often doesn't naturally mesh with the Internet's go-getter culture. Up next for Allina are Internet solutions to help further improve service levels, Pryor says. The organization would like to eliminate its admitting offices and move those functions online. That would allow patients to register before arriving at the hospital and even direct them straight to their rooms. Other future efforts will be determined based on availability of capital Pryor says. Those might include distributing radiology results over the Internet and moving other processes online to help improve the quality of patient care.

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