The Applicability of Porter’s Generic Strategies in the Digital Age Assumptions, Conjectur

Journal of ManagementDOI: 10.1016/j.jm.2003.12.0012004; 30; 569 Journal of Management Eonsoo Kim, Dae-Il Nam and J. L. Stimpert Assumptions, Conjectures, and Suggestions The Applicability of Porter’s Generic Strategies in the Digital Age:/cgi/content/abstract/30/5/569The online version of this article can be found at: Published by:On behalf of:Southern Management Associationcan be found at:Journal of Management Additional services and information for/cgi/alerts Email Alerts:/subscriptions Subscriptions:/journalsReprints.nav Reprints:/journalsPermissions.nav Permissions:/cgi/content/refs/30/5/569SAGE Journals Online and HighWire Press platforms): (this article cites 35 articles hosted on the CitationsThe Applicability of Porter’s Generic Strategies in the Digital Age:Assumptions,Conjectures,and SuggestionsEonsoo KimDepartment of Management,Korea University,5-1Anam-dong Sungbuk-ku,Seoul,136-701,South KoreaDae-il NamLG Economic Research Institute,LG Twin Towers,East Tower33rd Floor,20,Yoido-dong Youngdungpo-gu,Seoul,150-721,South KoreaJ.L.Stimpert∗Department of Economics and Business,Colorado College,14East Cache La Poudre Street,Colorado Springs,CO80903,USAReceived16October2002;received in revised form10July2003;accepted16December2003Available online15June2004Because current management theories evolved in the context of brick-and-mortarfirms,this paper examines three key questions raised by the advent of e-business:(1)Will the strategy types found among e-businessfirms resemble Porter’s(1980)generic strategies?(2)Will we find performance differences among e-businessfirms pursuing different types of strategies?(3) Will wefind differences in the strategy-performance relationships of pure onlinefirms(pure plays)andfirms with both online and offline operations(clicks-and-bricks)?We conclude that integrated strategies that combine elements of cost leadership and differentiation will outper-form cost leadership or differentiation strategies.We also argue that,regardless of business strategy type,clicks-and-bricksfirms that closely integrate their on-and offline operations will enjoy performance advantages over their pure play counterparts.©2004Elsevier Inc.All rights reserved.Enthusiasm for e-business has waned since the Internet boom of the late1990s,but busi-ness activity on the Internet continues to grow.A recent Business Week article claimed“the Net is actually delivering on many of its supposedly discredited promises...It is helping∗Corresponding author.Tel.:+17193896418;fax:+17193896927.E-mail addresses:eskim@korea.ac.kr(E.Kim),dinam@mail.lgeri.co.kr(D.-i.Nam),LStimpert@(J.L.Stimpert).0149-2063/$–see front matter©2004Elsevier Inc.All rights reserved.doi:10.1016/j.jm.2003.12.001570 E.Kim et al./Journal of Management200430(5)569–589companies slash costs.It is speeding the pace of innovation and jacking up productiv-ity...Of the publicly held Internet companies that survived the shakeout,some40percent were profitable in the fourth quarter of2002”(Business Week,2003b:44) is now the top leisure-travel agency online or off,while13percent of all traditional travel agency locations closed in2002.Expedia also has higher profit margins than American Express.Nearly every public Internet-basedfinancial services company is profitable.And, while less thanfive percent of all shopping is done online,eBay will become one of the top 15retailers in the United States during2003,and will move into the top40 (Business Week,2003b).Andy Grove,chairman of Intel,has recently stated,“Everything we ever said about the Internet is happening”(Business Week,2003a:86).In surveying this new economic landscape,Scott and Walter(2003)concluded that In-ternet technologies constitute a major business innovation,and suggested that this is reason enough for research into the challenges,problems,and opportunities facing e-business firms.And,based on their review of the e-business literature,Ngai and Wat(2002)noted that e-business research is emerging as a major stream of management scholarship,and that the pace of e-business research is likely to quicken in the future.One important question is how this new information age differs from the machine age of the last100years.Managers and scholars alike are struggling to understand how economic and business rules have changed and should change.Many have claimed that existing busi-ness and management concepts will not be applicable in this new environment.Others argue that the Internet is nothing but a new business tool and that not much has really changed.In their review of the e-commerce literature,Amit and Zott(2001)concluded that researchers have not yet articulated the central issues related to the e-business phenomenon,nor have they developed theories that address the unique features of virtual markets.They suggested two important questions for future research and scholarship:(1)What are the sources of competitive advantage in online markets,and how do they differ from the sources of advan-tage in offline markets?and(2)Are strategy perspectives and tools that were formulated in a competitive landscape inhabited by offlinefirms still relevant in the new world of e-business? This paper addresses these important issues by examining how existing strategy frame-works,models,and tools are,and are not,applicable in this new Internet age.We explore: (a)when the strategy types found among e-businessfirms resemble Porter’s(1980)generic strategies,(b)when we willfind performance difference among e-businessfirms pursuing different strategy types,and(c)when we willfind differences in the strategy-performance relationships of pure onlinefirms(pure plays)andfirms with both on-and offline opera-tions(clicks-and-bricks).Although current management theories evolved in the context of brick-and-mortarfirms,we propose that Porter’s generic strategy framework is still appli-cable,albeit in need of some modification,to competition in the digital age.BackgroundPorter’s TypologyA major stream of strategy research examines the relationship between strategy type and firm performance(Carter,Stearns,Reynolds,&Miller,1994;Dess&Davis,1984;Fahey&E.Kim et al./Journal of Management200430(5)569–589571 Christensen,1986;Kim&Lim,1988;Miller,1987;McDougall&Robinson,1990).These strategy types,sometimes called generic strategies(Porter,1980),archetypes,or gestalts (Robinson&Pearce,1988),simplify a myriad of possible strategies into a limited set of strategy types.Here,we focus on Porter’s framework of generic strategies for a couple of reasons.First, Porter’s framework of generic strategies is inherently tied tofirm performance.Second, Porter’s framework overlaps with other typologies.For example,Porter’s strategy of differ-entiation resembles Miles and Snow’s(1978)prospector strategy,and Porter’s strategy of cost leadership is similar to Miles and Snow’s defender and Hambrick’s(1983)and Dess and Davis’s(1984)cost leadership strategies.Porter’s strategy of focus is very much like Miller and Friesen’s(1986)niche innovator strategy.Porter’s framework proposes thatfirms must choose whether to serve broad or narrow market segments and whether to seek advantage through low costs or perceived uniqueness. Firms choosing to serve broad markets and to derive advantage through low costs are termed “cost leaders,”while those that seek to derive advantage through uniqueness are termed “differentiators.”Firms may also pursue“focus”strategies by targeting narrow market segments and by emphasizing either low costs or uniqueness.According to Porter,somefirms do not pursue a viable business strategy,and he labels thesefirms“stuck in the middle.”According to Porter,firms become stuck in the middle for one of two reasons.First,they might fail to pursue successfully any of the generic business strategies.For example,afirm might fail to differentiate itself from its competitors,but it may also fail to develop the capabilities or resources needed to be a successful cost leader. Porter has also suggested thatfirms can become stuck in the middle by trying to pursue more than one generic strategy simultaneously.Characteristics of the E-Business EnvironmentWhile Porter’s typology has received a good deal of empirical support in traditional busi-ness contexts(Dess&Davis,1984;Hambrick,1983;Miller&Friesen,1986;Miller,1988), we do not know whether Porter’s generic strategies or any other strategy typology can be applied to e-businessfirms(Smith,Bailey,&Brynjolfsson,1999).An extensive body of lit-erature has already described the essential characteristics of the e-business environment and how it differs from and is similar to traditional business environments(e.g.,Armstrong& Hagel,1996;Bakos,1997;Burke,1996;Cross&Smith,1996;Murphy,Hofacker,& Bennett,2001;Porter,2001;Schlauch,&Laposa,2001).Here,we highlight aspects of the e-business competitive landscape that are most relevant to the concept of competitive strategy.How is e-business different?The Internet allowsfirms to overcome physical boundaries and distance and it also allows them to serve larger audiences more efficiently.At the same time,and perhaps more importantly,Web technologies allow companies to target specific consumer groups,which may be difficult to do in traditional markets due to the high cost of obtaining information about a particular customer segment.Furthermore,traditional marketing methods usually emphasize only one-way communication from marketers to consumers,while the Internet is an interactive medium(Yelkur&DaCosta,2001).Since572 E.Kim et al./Journal of Management200430(5)569–589informationflows both ways between retailers and customers,firms can use the information gathered through customer interactions to develop more effective marketing methods,to refine their product mix,and to offer better customer support(Wang,Head,&Archer, 2002).As a result,the Internet allowsfirms to go beyond market segmentation to market fragmentation,dividing their markets into ever-smaller groups of customers–even tailoring their offerings to individual consumers(Robert,1993).Second,the Internet providesfirms with more detailed and higher quality information on customer rmation technologies making use of point of sale data have been used to improve inventory management and customer analysis,but this information tends to be rather crude since it usually includes only merchandise descriptions and quantities sold.On the other hand,vast amounts of rich data can be collected,analyzed,and accessed through the Web by marketers and consumers.This gives e-businessfirms potentially very important advantages in being able to target their product or service offerings to specific customers.For example, uses collaborativefiltering software to offer its users customized page views based on past searching habits.The software also permits Amazon to engage in anticipatory marketing by suggesting titles that may appeal to customers.And, consumers gain by readily obtaining more market knowledge for criteria comparison(Head, Archer&Yuan,2000).The Internet also offers significant opportunities for reducing operating costs,particularly for servicefirms.A study by Andersen Consulting(as cited in Yelkur&DaCosta,2001) provides examples of improved transaction efficiency for service industries such as travel andfinancial services.For example,the average cost of a banking transaction at a local branch is$e of an ATM machine reduces this cost to$.27,but performing this same transaction over the Internet costs a mere$.01.A typical reservation made through a travel agent costs$10.00,but this same transaction made over the Internet costs only$2.00.What has not changed?On the other hand,we believe manyfirms have been trapped by what we would characterize as“the myth of lower cost and price”–that there are no limitations to how much costs and prices can be reduced.If the bust proved anything, it’s that e-businesses must have viable business models.In fact,many e-businesses have found that they must incur considerable costs and make sizeable investments to provide value to their customers(Porter,2001) has,for example,made large investments in its distribution facilities.Other companies have found that virtual activities do not eliminate the need for physical activities,but often amplify their importance.The introduction of Internet applications in one activity often places greater demands on physical activities elsewhere in the value chain.For example,direct ordering makes warehousing and shipping more important.Similarly,while Internet job-posting services have greatly reduced the cost of reaching potential job applicants,they have alsoflooded employers with electronic resumes.By making it easier for job seekers to distribute resumes,the Internet forces employers to sort through many more unsuitable candidates.The added back-end costs, often for physical activities,can end-up outweighing up-front savings(Porter,2001). Interestingly,Internetfirms do not necessarily offer lower prices than traditionalfirms. Clay,Krishnan,Wolff,and Fernandes(2002)found that,on average,total prices were lower in physical bookstores than at online bookstores because sales taxes tend to be less expensive than shipping costs.Lee and Gosain(2002)reported a similar conclusion in the pricing ofE.Kim et al./Journal of Management200430(5)569–589573 CDs.The Internet marketplace continues to show price dispersion despite the apparently near-zero search costs for consumers.Many products and services sold by online retailers are the same as those offered by offline retailers.The primary attraction of online shopping is that customers enjoy rich informa-tion and convenience.At the same time,consumers can be overwhelmed by information overload,and they may actually perceive an increase in their search costs.Furthermore, consumers often view online shopping as being riskier than traditional shopping channels. Orders are contracted before consumers receive or physically evaluate merchandise,and the delivery process may also generate risks if consumers do not receive their orders in the time frame and condition expected.Consumers also risk privacy loss(Head et al.,2000). The Internet provides an efficient means to purchase products and services,but cata-log retailers with toll-free numbers and automated fulfillment centers have been around for decades offering a convenient,consumer-friendly interface and speedy delivery.The Internet only changes the customer interface(Porter,2001).In the context of electronic commerce,the functions provided by Web sites can be classified into three phases–pro-motion,online transaction,and after-sales phases–and the activities associated with each of these phases are not all that different from the activities that are associated with offline transactions.The promotion phase includes a company’s efforts to attract customers by advertising,public relations,new product or service announcements,and related activi-ties.Customers’electronic purchasing activities occur during the online transaction phase, where orders and charges are placed electronically through a Web-based interface.As in any type of transaction environment,trustworthiness,dependability,and reliability are im-portant catalysts in triggering sales.The after-sales phase includes customer service and problem resolution.This phase should generate customer satisfaction by meeting demand, addressing any concerns,and pleasing customers(Liu&Arnett,2000).Generic E-Business StrategiesAssumptions and Necessary Conditions for E-Business Competitive StrategyWe cannot say with certainty whether the new e-business environment represents a totally different,discontinuous change from the old business environment or whether the old and new environments will share many features and competitive challenges.We therefore make several assumptions about the application of conventional generic strategies in e-commerce settings.One critical assumption underlying this paper is that electronic technologies create a platform to support existing business practices and that we have not advanced to the point of precipitating a paradigm shift(Porter,2001).As a result,we assume thatfirms still view customers in terms of shared characteristics(i.e.,market segmentation is possible),that different sets of customers have different needs and desires(i.e.,opportunities for product differentiation exist),and that products and services exhibit different demand elasticities (i.e.,firms may compete on price).In addition to this assumption,at least two other conditions seem necessary for e-business success.First,online businesses must offer some minimally acceptable level of service,con-574 E.Kim et al./Journal of Management200430(5)569–589venience,and panies offering products or services online must demonstrate that they provide real benefits(Porter,2001).The demise of ’s reverse auc-tion business demonstrates that the benefits offered by any e-business must significantly outweigh any inconveniences suffered by customers.Second,a broad range of factors can serve as sources of differentiation,and many factors, including reliability and convenience,can help onlinefirms differentiate themselves from otherfirms.At the same time,we believe that some factors,such as security,are simply necessary conditions for the success of any online business.Customers will not pay for products or services over the Web if they do not believe their credit card information will be transmitted securely(Liu&Arnett,2000).Yang and Jun(2002)found that reliability was the most important consideration for regular Internet customers,while those who do not shop on the Internet identified security as their most critical concern.Our brief overview of the e-business landscape and these assumptions and necessary conditions suggest two plausible scenarios of competitive strategy:First,due to the power of search engines and the ease of making price comparisons,Internet retailers will be forced to charge essentially the same price,giving an advantage to successful cost leaders. Alternatively,firms will strive to compete on factors other than price,giving an advantage tofirms that employ successful differentiation strategies(Clay et al.,2002).In the following sections,we explore these strategic options and consider possible variations.Cost Leadership StrategyCost leadership can be an obvious strategic choice for many e-businessfirms.Although lower costs do not necessarily mean lower prices,lower prices have been a key selling point for e-businessfirms like ,CDnow,and many others,at least in the early stages of their development.The cost leadership strategy may be particularly appealing to online buyers who are price sensitive.In one study conducted in Korea,71percent of500first-time online shoppers indicated that price was their most important consideration(Kim&Kim, 2000).The Internet also allowsfirms to adjust their prices quickly so they can enjoy greater pricingflexibility and more efficient price competition(Bakos,1998;Lee&Gosain,2002). The Internet also helps consumers overcome bounded rationality in terms of price scan-ning.The longstanding satisfying argument(Cyert&March,1963)may be less applicable in the Internet environment since the speed and expansiveness of information search on the Web enable consumers to quickly gather a wealth of data for price comparisons.Price com-parison sites can further reduce search costs,so sophisticated Internet users can benefit from nearly perfect information acquired at little or no cost(Bakos,1997).Internet technologies also provide buyers with easier access to information about products and suppliers,thus bolstering buyer bargaining power(Porter,2001).Another characteristic of e-businesses is the law of increasing returns(Arthur,1996).For afirm to enjoy increasing returns,it must secure a critical mass of consumers as soon as petitive pricing is often the quickest and easiest way for afirm to secure the largest number of consumers.If the Web brings considerable pressure to bear on prices,firms may conclude that they have no choice but to pursue a strategy of cost leadership.Porter(2001)argues that it is difficult for onlinefirms to differentiate themselves,since they lack many potential points ofE.Kim et al./Journal of Management200430(5)569–589575distinction such as showrooms,sales personnel,and service departments.Moreover,Internet brands have proven difficult to build,perhaps because the lack of a physical store location or direct human contact makes virtual businesses seem less tangible to customers.Despite huge outlays on advertising,product discounts,and purchase incentives,most brands have not approached the power of previously established brands,achieving only modest levels of customer loyalty and creating few barriers to entry(Phau&Poon,2000).Differentiation StrategyAs noted above,differentiation can be based on many elements or factors,including design,brand image,reputation,technology,product features,networks,and customer ser-vice.Any successful differentiation strategy must be based on elements that are difficult for competitors to imitate.In spite of conditions that encourage e-businessfirms to compete on price,we believe that many if not all of these differentiating elements can also be used by e-businesses to distinguish themselves from competitors.The Internet’s lower switching costs should also encourage e-businesses to pursue a strategy of differentiation.In traditional businesses,consumers often tolerate mediocre products and services due to high switching costs.In the e-business environment,however, consumers can get access to information that was previously impossible to obtain or to compare,and can,with just a few mouse clicks,easily switch tofirms that offer additional value through differentiated features(Kim,2000;Porter,2001).As a result,e-business retailers will gain advantage if they can offer differentiated products and services,and they must also seek additional ways to distinguish themselves(Kim& Lim,1988;Miller,1991).In addition to traditional differentiating factors such as brand image,product features,and customer service,many e-businesses are also differentiating their distribution channels by emphasizing speed of delivery,convenience,and the security of transactions.Amit and Zott(2001)concluded that trust and security can be keys to “locking-in”customer purchases and loyalty.Liu and Arnett(2000)identified characteristics of Web sites that help online retailers differentiate their offerings,including the quality of information and the level of service pro-vided by the site,perceived quality of products and services,interactive feedback between the retailer and customers and the level of customization offered to individual customers, Web site“playfulness”that promotes customer concentration and excitement,system de-sign features that offer well organized hyperlinks,customized search functions,high-speed access,ease in correcting server errors,and follow-up services to customers.The few empirical studies that have examined the efforts of e-businessfirms to differenti-ate themselves have confirmed the importance of branding and other non-price factors.For example,a study of13online bookstores and two nationwide chains with physical stores found that prices were essentially the same at all of the retailers and that online prices had not converged to the lowest prices(Clay et al.,2002).In spite of its low-price claims,the study found that ’s unit prices werefive percent higher than ’s prices and11percent higher than ’s prices,providing some indirect evidence of product differentiation.The two leading online retailers of CDs in the US that together account for more than80percent of the total market share are not the dominant price leaders (Lee&Gosain,2002).Thesefindings suggest that customers may be“price rational”but not576 E.Kim et al./Journal of Management200430(5)569–589necessarily“price obsessive,”and that they have a strong inclination to be loyal to a retailer that offers a satisfying shopping experience(though not necessarily the lowest prices). Although popular sites like frequently advertise their low prices,many people are also attracted to these sites because of their brand reputation and credibility(Smith et al.,1999).Chang(1997)found that customers of Internet bookstores in Korea saw brand (of a company)as more important than the prices charged for books.He also reported that more people used these Web sites to search for information and tofind certain books than to compare prices.Lynch and Ariely(2000)found that,even in highly competitive e-business environments,buyers are less sensitive to price when they were given more information about how a particular product or service might meet their wants or needs.Other studies emphasize the importance of service and convenience as differentiating elements.Yang and Jun(2002)found that customer loyalty comes from an Internet company offering better service than otherfirms.Reichheld and Schefter(2000)also found that convenience was the top priority for the largest single segment of online customers,and that these customers were willing to pay more for greater convenience.Focus StrategyFirms pursuing a focus strategy target specific groups of buyers,product lines,or geo-graphic areas.Within their more limited market scope,they emphasize either low costs or differentiated products and services.Many Internet companies are new entrants,and they will logically choose to compete against large,establishedfirms by focusing on a particular market niche.In addition,the lower levels of investment required by many online businesses means that they enjoy lower break-even points than competitors with higher levels offixed costs.Thus,targeting even small market segments might be viable,and consumers may be easily connected with companies that focus on niche markets due to the Internet’s search advantages.Furthermore,the Internet allowsfirms to customize their offerings to meet the specific wants and needs of their customers(Bakos,1998).Customers are identified every time they visit a Web site,and a great deal of information about each customer can be accumulated over time.Based on this information,firms can customize products or services for particular customers.In fact,the Internet is the ideal medium for serving the fragmented nature of today’s consumer markets,and it is becoming increasingly viable for afirm to commu-nicate and deliver content over the Internet to small niche markets(Yelkur&DaCosta, 2001).As already noted,Internet businesses can face extreme price competition when products and services are similar because other factors that moderate competition(e.g.,store loca-tion)are not present.When products and services are capable of significant differentiation, however,the Internet can help segment consumers and direct them toward the appropri-ate product or service,as is the case in the hotel industry.The more specific the segment, the easier it is to estimate demand,and the Internet facilitates this micro-segmentation or fragmentation.As a result,e-businesses pursuing a focus strategy may have the ability to charge higher prices by matching buyers’needs with specific product or service offerings. In traditional business settings,this same degree of personalization would be relatively more expensive to offer(Yelkur&DaCosta,2001).E.Kim et al./Journal of Management200430(5)569–589577 Focused customer recruitment and retention are foundations of customer loyalty in any business setting,but they are musts for any e-businesses.In fact,we believe that focus is a necessary condition for a successful e-business competitive strategy.E-businesses that do not take advantage of the focusing–or fragmenting–capabilities of the Internet will be unlikely to establish a competitive advantage.Successful e-businesses shouldfind that Internet technologies make Porter’s(1980)competitive scope dimension infinitely scalable. As noted earlier,scalability and market scopeflexibility–the ability to serve simultaneously (or in quick succession)broad markets and very small market niches–are hallmarks of Internet technologies.As a result,we believe that the traditional focus strategy is not as relevant or viable in the e-business business-to-consumer context.In short,the strategy of focus is more of a competitive imperative than a competitive option for e-businessfirms.Generic Strategies and E-Business PerformanceCost leadership is widely practiced today among e-businessfirms that sell standard-ized products and services such as books()and travel(). Indeed,amongfirst-time online shoppers,price may well be the most important factor influ-encing their buying decisions(Kim&Kim,2000).This may be partially attributable to the ease of scanning and comparing prices on the Internet(Bakos,1998).However,easy price comparisons and very low customer switching costs suggest thatfirms pursuing a strategy of cost leadership could easily become locked in a vicious cycle of price-cutting. Because the Internet is an open system,companies have more difficulty maintaining pro-prietary offerings,thus intensifying the rivalry among competitors.Internet technologies tend to reduce variable costs,tilting cost structures towardfixed cost and creating signif-icantly greater pressure for companies to engage in destructive price competition(Porter, 2001).In addition,firms pursuing cost leadership will turn to outside vendors that offer the same products and services to otherfirms,so that purchased inputs become more homoge-neous,further eroding company distinctiveness and increasing price competition(Porter, 2001).Since the Internet also mitigates the need for an established sales force or access to existing marketing and distribution channels,barriers to entry are further reduced.Given all of these drawbacks,Merrilees(2001)concludes that,while low prices are important to customers,a generic strategy of cost leadership has many drawbacks for e-businessfirms. Magretta also reaches a similar conclusion in a recent Harvard Business Review article: It was precisely this kind of competition–destructive competition,to use Michael Porter’s term–that did in many Internet retailers,whether they were selling pet supplies,drugs, or toys.Too manyfledgling companies rushed to market with identical business models and no strategies to differentiate themselves in terms of which customers and markets to serve,what products and services to offer,and what kinds of value to create.(2002:91) Therefore,differentiation,based either on customizable products and services,on a cus-tomized online experience,convenience,or some combination of all of these factors,is likely to be a more viable strategy.Firms like that reduce customer search costs, engender trust,and offer products,services,and online experiences tailored to end-users’needs are likely to elicit initial and repeat purchases.。