The Strategic Impact of the Internet in a Given Industry

Javier Solá <jsola@aui.es>
Executive Director of the Spanish Internet Users Association

1. Introduction

The goal of any business strategy is to achieve a competitive advantage within the company's industry. The following article analyzes how the Internet can influence a company's competitive advantage and to what extent it should be taken into account when planning to implement corporate strategies.

When considering the Internet as a possible distribution channel, it is necessary to look into the future and ask how this network may change our industry over the next two or three years. It is not sufficient to consider the possible advantages; it is also of prime importance to assess the possible damage our competitive advantage could suffer if other businesses of the particular industry entered the Internet and it became an important distribution channel for our line of activity.

1.1 The Internet

Before carrying out such an analysis, we must first define clearly what the Internet is: a mere information channel or a complete distribution channel? In order to set about this task, we must realize that the Internet is merely a physical medium that provides a base for certain services. It is how interesting these services prove to be that will indicate the true value of the network. The main services are e-mail, newsgroups, and the Web. The possibilities offered by each are very different, as are the rules governing them.

E-mail allows fast, inexpensive, and asynchronous communications. (It is not necessary for the two people communicating to do so at the same time.) In this regard, it has merits that the telephone (synchronous), the fax (expensive), and the postal service (slow) all lack. It is personal and, therefore, discrete (provided that nobody with sufficient means tries to intercept it). The main problem of using it in commercial transactions is lack of security: Security protocol is still not sufficiently widespread.
Newsgroups are a form of receiving information on specific subjects that interest us and of disseminating information aimed at particular people who may be interested in it. Their merit lies in the fact that the information is unrestricted and is not screened by the major communications corporations. While the newsgroups provide an interesting source of information for industries, their use does not cover commercial purposes for ethical reasons of the network.
Finally, there is the World Wide Web. The Web has broken through the barriers of the not-so-friendly Internet and has made it a user-friendly tool. It has transformed an information network into a real information channel that is open not only to hackers and people with a special interest in information, but to the public in general, that is buyers. In short, it has changed the anticommercial Internet into a commercial network that will eventually become an important distribution channel.

Information (communication) channel or distribution channel? Where does the difference lie? It is perhaps easier to explain the difference using an example. Newspapers and television are communication channels. They enable messages to be put across to the public but do not allow commercial transactions to take place. A distribution channel necessarily provides sellers with a means of informing potential customers about their supply of products and enables customers to make their purchases (order and payment). The delivery of physical goods or services is not included in the distribution channel. (A travel agency informs and sells but is not involved in the provision of services.) A distribution channel can be strengthened by means of advertising through communication channels (media).

Only a combination of the Web and e-mail can provide us with a full distribution channel. The Web is used to inform clients, and e-mail to place orders. To simplify the process, e-mail can be generated directly from the Web.

It should be pointed out that, as we will see later, the Web does not need to become a distribution channel for it to influence companies' competitive advantage.

2. Porter's model

2.1 The model

In order to be able to analyze the strategic implications of the Web, we must apply a theoretical model (which is, nevertheless, of practical use). In business strategy, one particular model stands out among the rest and has been applied satisfactorily to information technology: that of Michael Porter.

Porter's basic model is extremely simple, yet exhaustive. It is based on five forces that influence the competitive advantage of a business within its industry (and that consequently should be taken into account when developing corporate strategy). These forces appear in figure 1.Figure 1

Figure 1

The diagram shown in figure 1 can be summed up as follows: Companies competing in a particular, established industry are interested in positioning themselves in the market but, above all, share a common interest in not letting anybody else in (to prevent the competition from growing stronger); in preventing new products or services that could replace their own from appearing; and, lastly, in ensuring that their internal competitiveness does not give rise to an increase in suppliers' or clients' negotiating power. It is by controlling all these factors that a company may obtain a competitive advantage in its industry.

This article analyzes how the Web can influence each of these forces. The analysis is by no means exhaustive, for the real potential of the network is as yet unknown; nevertheless, it enables us to begin to reflect on the future and to consider how the network may be used to obtain and maintain a competitive advantage.

There are a number of factors that determine the "strength" of each of these forces. Some of these factors influence several forces simultaneously. The following chapter explains how each of these factors affects one or several of the forces. Chapter three analyzes how the Web can alter these factors and modify them.

2.2 Factors that influence competitive advantage

2.2.1 New competitors

The strategic analysis should be applied both to companies already in the industry and to those wishing to enter it. The industry defends itself against new competitors by creating entry barriers. There are different kinds of barriers:

Economies of scale: For a business to be profitable in the industry segment, it is vital to produce large quantities that enable prices to be competitive. It is not possible to enter a market if only a small share can be secured.
Control of distribution channels: If a new potential competitor cannot reach clients of the industry because it has no access to existing distribution channels-and is unable to create new channels-it will not be able to compete with the established companies.
Switching cost: This refers to the costs incurred by a company when switching to another supplier (search, change in working methods, new personnel, acceptance of worse conditions of payment, etc.).
Product differentiation: This is the position a company has acquired in the market. It is difficult to enter a market where there are well-established companies whose names are almost synonymous with the product itself.
Capital requirements: In some industries, an extremely high initial outlay is required in order to enter the market, for example, R&D or manufacturing machinery.
Other cost advantages not related to economy of scale: Factors such as ownership of patents (to avoid paying royalties) or having access to low-cost distribution channels favor existing companies.

2.2.2. The negotiating power of suppliers

Since the beginning of the 1970s, some of the big distributors have succeeded in installing their own computer system terminals in the offices of their main clients. This is the case of Baxter Healthcare Corporation (BHC) in the United States, one of the most important distributors of pharmaceutical products. BHC began by installing a punchcard reading device in a California hospital. The hospital was given a punchcard for each article supplied by BHC. When a card was inserted in the reading device, an identical card was automatically punched in BHC's offices. The set of cards punched were considered to be a firm order. The punchcards were eventually replaced by a terminal and later by a personal computer installed with software for handling orders. In some cases, the hospital computer even prepared orders automatically when the hospital stocks dropped below a set minimum. These orders were sent directly to BHC's computer.

Such a close relationship between supplier and customer entails enormous advantages for both. The simplified, centralized purchase system and automated updating of inventory and entry of invoices in the accounting system mean that the hospital needs fewer staff to handle purchases. Furthermore, the supplier does not need to feed the orders into its computer, since they arrive electronically. This prevents errors and a great deal of unnecessary work. Orders can also be delivered more promptly and the hospital can, therefore, reduce its stocks.

Nevertheless, this apparently idyllic relation also has a number of disadvantages. Upon accepting the supplier's system, the customer gains many advantages; but using the simplified structure makes it very difficult for the customer to switch to another supplier that does not have a similar system. The supplier may then raise prices and even begin to offer inferior service, yet the customer will think twice before changing to another supplier.

The opposite case is the relationship between companies that manufacture products (client) and those that design them (supplier of the design). Products designed using computer aided design (CAD) can travel from the supplier's computer to that of the client, be modified and returned for examination, etc., until the product is finished. This kind of relation can reduce design time by as much as 90 percent. In this case, it may well be the client who has forced the supplier to work with a particular CAD system; but once the mechanism is in use, the cost of switching to other suppliers is high, unless the new supplier already uses the same system as the client. This time it is the client who, in order to acquire a competitive advantage, hands over power to the supplier.

In short, any advantage held by a client arising from a close customer-supplier relationship can be transformed into a switching cost.

2.2.3 Negotiating power of customers (buyers)

If the cost of switching from one supplier to another is very low, competition between suppliers needs to be very fierce, as the market is very insecure. A more aggressive attitude is needed-not only at the marketing level, but in price, quality, and service.

In industries where customers have greater power (for example, car part manufacture), suppliers must accept all conditions imposed by the client, including technology, price, quality, delivery date, etc.

One of the factors that create a high switching cost is the lack of information buyers have regarding available suppliers, prices, and quality of service. Lack of information increases the supplier's negotiating power and reduces that of the customer.

2.2.4 Substitutes

At the end of the 1970s, fiberglass insulation manufacturers dominated the insulation materials for construction market. After a time, substitutes (cellulose, asbestos, mineral wool, etc.) that covered the same necessities and competed with fiberglass in price appeared. This competition forced fiberglass manufacturers to reduce their previously high profit margins in order to adapt to the new market.

The invention of synthetic dyes totally supplanted the natural dyes industry. The economy of a number of Central American countries was badly affected by this invention.

The only way of fighting substitute products that can control the market is by competing in price and performance or by seeking other products or services able to compete with the substitute.

2.2.5 Competition between companies in the industry

Competition within the industry segment is based on rivalry in price, advertising battles, new products, and service. Competitive advantage can only be acquired by producing at lower costs than the competition or through product differentiation.

In a balanced industry, a company's competitive activities generally provoke a response from its competitors, who endeavor to counteract them. If such activities are very aggressive-for example, a price war-the whole market suffers, as all companies are forced to lower their prices and the industry is needlessly impoverished. Markets with few competitors are usually more stable in this sense, especially if there are companies that are sufficiently large and charismatic to establish the guidelines for the market. Competitiveness tends to be fiercer in markets where the switching cost is low or nonexistent.

2.2.6 Summary of factors

If it is only from counting the number of times it is mentioned in this chapter, it is obvious that one of the most important factors in the acquisition or maintenance of the competitive advantage is the switching cost. A high switching cost favors suppliers that are already established in the industry. It gives them power over their customers, blocks the way to other companies wishing to enter the market, and protects them from competitors.

Another fundamental factor is control of the distribution channels. These are traditionally controlled by the established companies and seldom change, unless significant technological or legal changes occur. The new channels can provide companies interested in entering a saturated market with an opportunity to do so. The use of distribution channels that require a smaller structure than the usual or established channels can be classified as a form of cost reduction

An interesting factor that favors the buyer is information on suppliers. Suppliers are interested in making certain information available but should not allow it to be easily compared with that of other suppliers.

Finally, we might include the creation of new products (with increasingly shorter life cycles) in our list.

3. Possible strategic impact of the Web

Although this article deals primarily with the strategic impact of the Web, its conclusions may be applied to any other widely used network that is easily accessible. The network is analyzed from two perspectives: as a distribution channel and as a source of information that may affect competitive advantage.

3.1. The Web as a distribution channel

When we speak of the current Web, it should be pointed out that this is quite different from the Web that will exist in two or three years' time.

For our part, we would hope that by that time-

The conclusions of this article are based on these two principles. A delay in the commercial implementation of the Web could give rise to a general disillusionment and cooling-off of public interest. It is, therefore, important to take advantage of current enthusiasm to reach the greatest number of users.

As a distribution channel, the Web may be characterized as follows:

3.1.1 Possibility of controlling the distribution channel

The fact that the Web is not a controlled channel means that it is an access point for new companies. As a normal distribution channel, it cannot be controlled unless the companies in the industry succeed in focusing customers' attention on specific pages (a virtual market from which companies outside the market would be excluded). This could have two negative consequences:

One of the main characteristics of a distribution channel is that it should reach potential customers. How interesting the Web is as a channel depends on whether or not potential (or real) customers are connected. For the time being, sufficient numbers of potential clients only from very specific industries are connected (microcomputing hardware and software, universities, etc.). It is, therefore, currently a limited channel regarding the number of clients having access to it and markets that could be interested in seeking clients that are already connected.

Nevertheless, there are a number of products and services that are especially well-adapted to distribution through the Internet. These products-which in many cases would even force customers to get hooked to the Net-have one or several of the following characteristics:

These types of products may be found in many different industries. A company may decide to use the Web as a distribution channel only for products that are especially suitable. It may also take advantage of the fact that customers will visit their Webs on account of the interest aroused by these special items to include other products that are less adapted to this media.

However, an industry that controls the existing distribution channels may well not be interested in creating a new distribution channel it does not dominate, as this would mean opening itself up to new competitors.

Members of an industry with many distribution channels who seek new ways of competing-provided they are not concerned about letting new competitors in-can approach the Web as an alternative method of distribution.

In other cases, it will be new competitors who try to gain control of part of the market by creating a new channel. If they are successful, their competitors in the industry will be obliged to react in an attempt to maintain their share of the market.

It should not be forgotten that access to a distribution channel is just one of the factors that can prevent new competitors form entering a market. In addition to this, candidates must overcome the switching cost and other factors that hinder their entry.

3.2. Flexibility and swift change

Another interesting feature of the Web is that the information it offers may be changed very quickly, and this change reaches clients or buyers immediately. This is particularly important for industries in which competition is based on major advertising campaigns to promote new products with a very short life cycle. We should consider that advertising is part of the life cycle, and the shorter the cycle the greater the advantage.

Quick product change to adapt to the market not only ensures a specific competitive advantage, but also enables it to be maintained.

3.2.1 Cost

To some extent, the distribution of goods aimed at the public in general through the Web reminds us of catalogue sales. There are certain similarities:

We should however mention the differences:

The two systems are perfectly compatible. The catalogue sales company can publish its catalogue on the Web and use its existing structure to receive and send orders and for billing purposes, etc.

The interesting feature is that both are low-cost distribution channels. Access to the Web does not require a large investment. There is no need to own a server, as third parties retail this service at reasonable prices. If considerable information is handled and this is frequently updated, the cost of buying a server and connection to the network are soon recouped.

To be cost effective, a Web-based distribution channel should use existing corporate structures.

3.3. The Web as a source of information that could influence competitive advantage

Let us imagine for a moment that a consumer association compiles a database on washing machines, allowing prices, quality, and even complaints received by the association (as information on after-sales service) to be compared easily. Let us also suppose that this database is regularly updated, its existence is known, and access to it is easy-there are even terminals at washing machine sales outlets.

Direct comparison of prices, quality, and service received from an independent organization at the moment of decisionmaking can significantly affect the way potential buyers behave. The influence can even be stronger than a positive experience (the previous washing machine). This is because customers have all the information they need, and the switching cost is therefore very low.

Direct comparison would force washing machine suppliers to wage war on one another; not so much on the basis of marketing but rather centering on price, quality, and service.

When customers possess a large amount of comparative information, suppliers are forced to make a greater effort. In general, the suppliers' power decreases, obliging them to lower prices and improve quality and service.

This leads us to consider the fact that a large proportion of our commercial system is based on customers' lacking information on their options. There is a tendency to work with a series of suppliers that provide more or less satisfactory service. The customer will only make the effort to look for a new supplier if the level of satisfaction drops significantly (in other words, there is a switching cost).

This kind of information-based systems would make it easier for new suppliers to enter the market. Since the distribution channels are "fair," a supplier with attractive prices and good service could enter the market very quickly.

A possible conclusion would be that it is essential to control how information is distributed. It is important to give as much information as possible to potential clients, but it is also in our interest to ensure that this information cannot be used to give customers greater power and thus bring about a war in the market.

3.4 Changing competitive balance within the industry

It is impossible to carry out a global analysis on how the Internet can help companies to improve their competitive position within their industry. Each market is different and requires a specific analysis. Studies should often go beyond purely technical criteria.

Let us take the case of travel agencies, for example. In theory, if in a year's time everybody that is connected to the Internet will be able to reserve their air and rail tickets and book their holidays through the Net, we might assume that the future of travel agencies could be at risk. We should go further and consider who makes reservations in the company and how it is done. This task is normally part of the daily work of the secretaries. A secretary that needs a ticket has two options: to call the agency and let them to do all the work and send the tickets; or to learn to use the Internet reservations system, find the flights, study the connections, pay for the ticket; and organize how it is to be sent. Personally, I would prefer that my secretary called the agency and used the time she would have spent on the Internet in some other way.

Having direct access to services is not always an added value. Only those services that really add value to their use have a chance of succeeding in media such as the Internet.

A study on the competitive possibilities of the Internet in a particular industry should include all the factors that influence the distribution channel we wish to modify or operate in.

The Internet must not be considered as a global distribution channel for the industry. Each product or set of products should be studied separately.

4. Conclusion

The decision to enter the Web at the corporate level cannot be made by the computing department of a company. It should be carefully assessed by the general management. The latter should go beyond the technical details and focus on how the Web, as a new distribution channel, may affect competitive balance in the industry, both at present and in the next two or three years.

If we consider that the Internet may become an important channel, albeit in the future, it is essential to act swiftly. Otherwise, we may well find ourselves at a disadvantage at a time when the Internet has become central to market development within the specific industry.

About the author

Javier Solá is currently executive director of the Spanish Internet Users Association.

He studied computing and computer architecture in the United States, at Duke and Ohio State Universities.

Following this, he worked for four years at the Research Center and The Artificial Intelligence Development Center of BULL S.A. in Paris, where he specialized in the solution of complex planning problems and management of large projects.

In 1990, he returned to Spain, where he worked as an independent consultant until 1995, when he joined the Association.

In addition to consultancy work, Javier Solá has taught artificial intelligence at Zaragoza and San Sebastián Universities, as well as at two of the most prestigious French universities. Over the past two years, he has also taught "Strategic Impact of Information Systems" as part of the syllabus of the University of Boston master's degree in business administration in Spain.

Javier Solá is 35 years old.