Q&A: Caught in the Net

Harvard Business School's Michael Porter reflects on how companies misread the first great dot-com wave--and suggests ways the New Economy may evolve

Few business school professors have been as influential or as well known as Harvard Business School's Michael E. Porter. Twenty-one years ago, this management thinker's landmark book, Competitive Strategy

, had immediate impact in both the business school classroom and the real world. Porter helped a generation of managers understand that superior profitability almost always comes from differentiation and the company's relative cost position.

So when observers began to promote the Internet as a competitive game-changer a few years ago, Porter took notice. After a trip to the West Coast during the spring of 2000, the strategy professor decided to put aside nearly everything else and attempt to understand what the new technology meant for management and strategy. Porter joined the advisory boards of several dot-com companies, and he became a board member of an Internet consulting firm. His conclusions--published before the dot-com bust--were sobering.

Senior Writer John A. Byrne recently asked Porter, 54, about the lessons of the high-tech bubble and the tulip-bulb-like mania that the Internet inspired.

Q: How was it possible for so many smart people to get caught up in what is now widely recognized as a bubble?

A: Management is a very faddish field. People are always looking for an easy explanation or an easy solution. There's a very strong tendency to take what might be a modest trend and essentially extrapolate it way into the future. People were already talking about revolution, transformation, and changing the game. The Internet came along, and it was a marriage made in heaven.

Amazon.com (AMZN ) comes online. It starts to sell books. Online bookstores start to grow, and all of a sudden online bookstores are going to take over the field. In fact, they seem to be reaching no more than 7% or 8% of book sales. So there's a tendency to "glom on" to a single powerful explanation for success. It's simple. It's clear. There's a bandwagon effect.

Q: Why did managers so seriously misread the actual demand for online commerce?

A: The way this technology was deployed in the first stage, virtually all the value went to the customer. In fact, 150% of the value went to the customer. Value was extracted from the corporate sector and passed to the consumer sector because people were able to buy things at [prices] much lower than their true cost. So shareholders basically subsidized consumers.

It's wonderful to get things for free or for much less than they're worth. But technology has to deliver value that people are willing to pay for. The problem with the Internet was that many of the things it did were not sufficiently valuable for people to pay for.

Q: What can companies do to capture more of the benefits and make the Net more of a competitive advantage?

A: We need to see the Internet as complementary to other things the company does rather than contradictory or cannibalistic. That was a really fundamental mistake that many people made. They assumed that this was a disruptive technology that existing companies could not embrace as efficiently as a new company coming in with a clean sheet of paper.

If you view the Internet as an applications tool, then you're just going to try to build the best applications. You're not going to get much of an advantage from that, because everyone else will do that, too. If you view it as a strategy tool, you'll ask yourself: "O.K., given my product concept and how I try to differentiate myself, how can I use the Internet to make that differentiation stronger?" It's really the tailoring of the Internet to the firm's unique strategy that will be the real opportunity for advantage.

Q: Why did so many people miss this?

A: Too often, people confuse change with disruption. What disruption means is that it invalidates or makes substantially less important the advantages of incumbents. The Internet didn't invalidate the importance of the product, the brand, the distribution system, or even physical locations like stores and warehouses. The Internet affected discrete parts of the value chain, but other parts of the value chain remained important. There was no inconsistency between having online ordering and having stores. You could do both together. The firm that really understands the product, the business, and the customer needs is probably in a better position to do a good job on the digitization.

Q: Is there a danger in going from irrational exuberance to irrational pessimism about what the Internet can accomplish?

A: I think there is. I'm 100% certain that this is a very important and very powerful technology. It will create a lot of change in the way business is done, and that change is not complete. The real issue is, how do we use the technology for competitive advantage? That's where people missed out. I think it would be very unfortunate if in the bungling of the application, companies today lost sight of the ultimate importance of the technology.

Many companies now are in a classical cyclical downturn where everybody's afraid. They just aren't sure when revenue will pick up again, so people have cut back on systems investments. But there's also a new rigor in insisting that a business case be made for Internet deployment. That is very healthy.

Q: How do you see this playing out?

A: The Internet as a family of technologies will have a very powerful effect on operational effectiveness. We'll see deeper integration among service, sales, logistics, manufacturing, and suppliers. The first level of that will improve efficiencies, reduce transaction costs, and reduce inventory. The first generation of those systems weren't all that effective. You see it in the downturn. The inventory control wasn't as brilliant as we all thought.

Q: Why was that?

A: The systems tended to be very partial. You could order online and buy from your suppliers. But you didn't know how much inventory your supplier had, and the supplier didn't have any special understanding of the marketplace. I think we're going to move to more complex, more integrated systems. Product design will not just be done in the firm but jointly with suppliers and customers.

Q: The high-tech boom also led many to rethink what the corporation would look like in the future. How lasting are some of those ideas, like heavy reliance on outsourcing?

A: The short-term cost savings of outsourcing were very apparent, very attractive, and very seductive to companies who were desperately trying to improve their earnings per share quarter to quarter. But when you outsource something, you tend to make it more generic. You tend to lose control over it. You tend to pass a lot of the technology, particularly on the manufacturing or service delivery side, to your suppliers. That creates strategic vulnerabilities and also tends to commoditize your product. You're sourcing from people who also supply your competitors.

Q: What's next?

A: Another big freight train is coming down the track in the U.S. economy. That's the tremendous long-term shortage of labor we are facing. We're very short of workers of any kind and particularly highly skilled scientists and engineers. So ways of bolstering the efficiency of people, such as the Internet, are important. I just hope companies will heed the message not to think of this as an operational efficiency tool but as a way to reinforce your own distinctive strategy. That's the way to turn it into an advantage rather than just something you have to do to be in the game.

By John A. Byrne

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