Skip to main content
Feature

Winning the Web Wars

Gaining Competitive Advantage in the Online Marketplace

"It's Dot-Com Doomsday... Second-tier dot coms are now nothing more than nuclear waste....It
could get worse." Fortune1

Forecasts predicting the viability of brick and mortar retailers as well as their Internet-only
competitors have dramatically shifted over the last year. Experts who used to say that "old
economy" retailers would get blown away by so-called "new economy" e-tailers are changing
their tune. 

Conventional retailers have had to quickly come to grips with how to best react to new
Internet-only competitors. Most have chosen either to attack cyberspace from within the
mainstream or to spin off their online business. As conventional retailers have become "clicks
and mortar" retailers, many Internet-only companies find the tables have turned. Hybrids have
been winning online customers away from pure plays and now appear to have the upper hand.
Not surprisingly, as pure-play valuations have fallen, recent headlines question whether pure
plays will survive. 

Results from our study of pure plays, spin-offs, and integrated online businesses in eight
key online retailing sectors books, music, toys, clothing, office supplies, drugstores, furniture,
and financial services show that doomsday predictions for both brick and mortar companies
and pure plays have been overblown.

We interviewed top executives from both conventional retailers (e.g., Charles Schwab, OfficeMax, Toys-R-Us) and Internet-only retailers (e.g., CDNOW, E-Trade, SmarterKids.com), and conducted a survey of one hundred retail companies. Our findings reveal how companies can gain competitive advantage in the online marketspace. The results also help predict online winners and suggest survival strategies for
Internet-only and conventional retailers.

Predicting Online Winners 

Conventional retailers compete better online by leveraging their complementary assets to deliver
value to the customer. An asset becomes complementary by increasing in value when used in
combination with a second asset. For example, if a company's web site is significantly more
valuable because the company also has brick and mortar stores, then the stores are viewed as
complementary assets. Spin-offs or imitations of pure plays can be a barrier to leveraging
complementary assets in the online marketspace. The figure below provides a useful model in
predicting online winners.

The two key dimensions that determine whether hybrids or Internet-only companies will
have online advantages are: 1) product selection complexity and 2) specialized operational
complexity. When product selection complexity is high, customers require information that is
difficult to capture in concise, standard terms. Customers often place a high value on the ability
to physically examine the product in stores. For example, customers buying furniture consider an
array of factors such as color, comfort, and style. As a result, physical examination of the product
is important increasing the value of brick and mortar assets. Internet-only companies are
virtually nonexistent in this retailing sector.

In other cases, customers value personal contact. In an investment decision, for example,
a customer might need to discuss how various stocks or financial investments fit into his or her
portfolio. Because the value of retail branch operations and human assets is high in financial
services, brick and mortar banks are gaining more online accounts than pure online banks. The
higher the product selection complexity and the need for complementary assets, the more we
expect integrated clicks and mortar companies to have competitive advantages in the
marketplace. 

There are cases when customers may value complementary assets even when
product-selection complexity is low. We found drugstore pure plays soma.com, drugstore.com,
and planetrx.com did not have the complementary assets required to meet customers'
convenience needs. Brick and mortar drugstore chains Rite Aid, CVS, and Walgreen owned or
had preferred access to Pharmacy Benefit Managers (PBMs) companies that handle complex
insurance paperwork. Customers who need immediate access to medicine value the option of
ordering online and picking up their order at the local drugstore. These advantages have
prompted all major pharmacy pure plays to seek a merger or an alliance with a brick and mortar
pharmacy.

When product-selection decisions are complex and when the operational complexity of
managing the physical value chain is high, the online winners will be bricks and clicks
companies that effectively leverage the value of complementary physical, human, and intangible
assets. In contrast, when product-selection decisions are simple and the operational complexity of
managing the physical value chain is low (as in books, music, and software), pure plays and
spin-offs will emerge triumphant.

Surviving as an Internet-Only Company 

Even though pure plays may be successful in terms of marketshare in the lower left quadrant of
the model, they may never make sustainably high profits. This is because these products tend to
be commodity-like with few barriers to entry. The real challenge for Internet-only firms is to
figure out how to compete in retailing sectors characterized by high product selection and
operational complexity. Pure plays can only compete effectively in highly complex retailing
sectors by: 1) free riding on competitors' assets; 2) destroying competitors' assets; or 3)
accessing the value of competitors' assets.

1. Free Riding on Competitors' Assets 

One way for pure plays to compete effectively in retailing sectors characterized by high
product-selection and operational complexity is to determine whether it is possible to "free ride"
on competitors' assets. This involves figuring out how to get customers to check out products
off-line and purchase products online.

For example, 1800-Mattress (1800mattress.com), an Internet-only mattress retailer, has
been successful at free riding on the store investments made by conventional mattress retailers
such as Sears and JCPenney. 1800-Mattress knows most customers prefer to lie down on a
mattress before buying it. Instead of building stores, it develops an inventory of products that
match what customers can buy in conventional stores. Then, it advertises that it can always
provide lower prices  than its brick and mortar competitors for the same product. All customers
have to do is go to mattress.com (or call 1800-Mattress) to identify the brand name and SKU of
the desired mattress. Customers receive a price consistently 10 to 20 percent lower than prices at
the local mattress store. 

A free-riding strategy works best when a product's inventory costs are high, when
customers need to touch and feel the product before buying, and when the online retailer can
offer an identical or virtually identical product. Automobiles, expensive consumer electronics,
and mattresses are examples of products that fall in this category. 

2. Destroying Competitors' Complementary Assets 

Internet-only companies can also compete by destroying the value of their competitors' bricks
and mortar assets. The easiest assets to destroy are those used to provide information or products
that can be digitized such as software. When products can be distributed more feasibly online,
the value of stores and other bricks and mortar assets such as warehouses and inventory systems
dramatically declines. 

As broadband connections become more common, this trend will accelerate. Online sales for software are predicted to reach nearly 50 percent of total software sales as early as 2003.2 Though the time horizon is likely to be considerably longer, books and music are other areas where the value of
complementary assets will decline as products become more widely available in digital form.

In addition to digitizing products, there are two other ways to destroy the value of
conventional retailer's assets. The first is standardizing or commoditizing the product being sold.
This involves simplifying the product-selection process by identifying areas of product-selection
complexity and standardizing them. For example, purchasing a personal computer used to be a
relatively complex decision before Dell and others simplified the decision-making process.
Today, with four to five pieces of information, most customers can make a purchase
decision as a result, online sales are booming.

The last way to destroy competitors' assets is to develop new virtual technologies that
deliver similar value to customers. For example, Lands End's "dress yourself" technology is an
attempt to provide a virtual dressing room for customers. Customers provide information on their
body type/size and select an article of clothing to "wear." This gives them the opportunity to
"see" the product and get a sense for how it will look. In addition, Land's End will mail
customers swatches of material so that they can feel the fabric and see color options. While
dress-yourself technology is still quite primitive, the idea is to use less expensive virtual
technologies to perform similar functions as brick and mortar assets. 

3. Accessing Competitors' Complementary Assets 

A final option for Internet-only companies is to access needed complementary assets through
partnerships with conventional retailers that are capable of managing complex physical product
flows. Just as traditional bricks-and-mortar firms in many industries have discovered, alliances are a fast and flexible way to gain access to complementary resources. Pure plays can provide the know-how in online transactions that some traditional retailers lack. At the same time, online retailers gain access to complementary resources they may need, such as brand names, purchasing power, physical outlets, and distribution networks that address both product selection and distribution concerns. 

Amazon's recent alliance with Toys-R-Us may foreshadow more alliances between pure
plays and traditional bricks and mortar firms. Amazon gets the benefit of Toys-R-Us' brand
leadership in toys and access to its enormous purchasing power. Toys-R-Us gains from
Amazon's considerable online know-how and its access to online eyeballs. 

Another way that pure plays may access complementary assets is to partner with firms
specializing in areas such as fulfillment and logistics. Both UPS and Federal Express have
formed units specializing in what they term eLogistics. Partners with strong logistics capabilities
might dramatically reduce the costs of fulfillment for online units and make them more
competitive with clicks and mortar companies. As with any alliance, success is largely
determined by partner selection and structuring a relationship that is mutually beneficial to all
parties in the alliance. An alliance with the wrong partner one lacking the most critical
complementary assets, or an alliance where the financial terms greatly favor the brick and mortar
retailer will only accelerate a pure play's demise.

Surviving as a Brick and Mortar Company 

Over the long run, hybrid clicks and bricks retailers must develop strategies to prevent
Internet-only companies from free riding on, destroying, or accessing their valuable
complementary, physical, human, and intangible assets. The major short-run challenge for hybrid
clicks and bricks retailers is organizational rather than strategic. In the near term, conventional
retailers should focus on exposing the weaknesses of pure plays that do not possess
complementary assets.

Touting the advantages of choosing an online retailer with complementary physical,
human, and intangible assets will resonate with customers in retailing sectors characterized by
high product-selection complexity and high operational complexity. To effectively leverage those
complementary assets in delivering value to online customers, conventional retailers must make
sure they effectively coordinate the activities of their online and conventional business units. 

Because there are large differences between running conventional versus online
businesses, there are real risks if a firm doesn't create some separation between the new online
business and the traditional business. Although integration is the key to leveraging
complementary assets, retailers must also realize that online businesses will need to be managed
differently.

Conventional retailers must figure out how to create enough separation for the online
business to flourish, while at the same time integrating the two business units to ensure there are
not missed synergies. Harvard scholars Paul Lawrence and Jay Lorsch showed long ago that it is
possible to achieve differentiation and integration simultaneously without using spin-offs.

Successful businesses in dynamic environments have long faced the dual challenge of
separation and integration. Different functional units often possess different mindsets, clock
speeds, and even subcultures. These differences help the various units adapt to the differing
tasks they face. To be successful online, hybrid retailers must effectively balance the demands
for separation and integration. They must create some separation or the online business will not
develop the distinctive values, processes, or resources necessary to succeed within an online
business model.3 They must also put in place integrative mechanisms to facilitate coordination
with bricks and mortar companies.

The following evolutionary approach is designed to help clicks and mortar companies
achieve the benefits of both separation and integration.

1. Create a Separate Organizational Unit with a "Re-Integration" Plan 

When traditional bricks and mortar businesses move online, they need new skills and processes
to adapt to fast-paced "Internet time." Because there isn't time to develop these skills within the
existing organizational structure, it is important to create a new organizational space where
appropriate new skills and processes can be developed. To facilitate the development of new
skills and processes, companies may want to look outside their company for the leaders of their
online unit. Outsiders are not locked into old ways and rhythms of doing business and are less
likely to impose the bricks and mortar processes and values on the online business.
The problem with "star" executives from traditional businesses running an online business is they often don't know that they don't have the knowledge required to successfully run an online business.

Of course, a major challenge facing outsiders is they lack company-specific knowledge
and may not design the online unit with an eye towards future integration with the conventional
business unit. Special attention must be given to helping outsiders understand complementary
resources within the firm to ensure that the online unit is designed to fully leverage the
company's brick and mortar assets.

Building a separate organizational unit creates the separation necessary for new skills and
processes to flourish but must be accompanied by key integrating mechanisms. One option for
getting the necessary integration is to set up a senior level integration team with the explicit
assignment to identify potential synergies between the two businesses and coordinate on strategy.

While the integration team may be advisory in nature during the early stages of
developing an online business, over time it may be useful for this group to have the
decision-making power necessary to ensure synergies are realized. 

2. Begin with Different Metrics, but Increasingly Use Common Metrics 

The right metrics help focus attention not only on key success factors but also on accountability.
The best measures for traditional bricks and mortar businesses may not be the best for online
activities. Kevin Kelly's statement that, "productivity . . . is exactly the wrong thing to care about
in the new economy"4 may overstate the case somewhat, but his general point is worth noting.

A focus on efficiency often leads managers to neglect exploring new opportunities.
Particularly in mature businesses, firm measures tend to focus on efficiency more than
opportunities. Online businesses need to be rewarded and measured more for growth than
efficiency. The different metrics for the traditional and online business and the logic for the
different metrics should be properly communicated throughout the organization. One of the
virtues of spin-offs greater accountability stems from clearer performance measurement.
Because there are fewer interdependencies with other units, profit and loss measures are less
ambiguous. This measurement clarity makes managers of these separate units more directly
accountable for the results they achieve. 

Historically, the only way to clearly measure an activity was to separate it and reduce its
interdependencies with other activities or units as much as possible. Without complete
separation, overall performance measures existed only at high levels of aggregation. Advances in
information technology and accounting innovations, such as activity-based accounting, now
make it more feasible for firms to get clear measures of performance without isolating activities
into separate units with separate profit and loss statements.

Winning the Web Wars 

Managers of today's firms are often faced with "bet the company" decisions as they struggle to
develop an effective online strategy. The traditional wisdom offered to conventional retailers has
been to spin off the online business as a separate entity, allowing it the freedom to "cannibalize"
the parent. We remind managers that there are considerable risks to spin-offs, because they make
it more difficult to leverage complementary bricks and mortar assets.

The online strategy or structure choice should be driven largely by customer needs not
by Wall Street. Spin-offs, while appropriate when product-selection and specialized operational
complexity are low, may result in missed synergies, brand confusion, and an inability to offer an
effective and well-coordinated path for existing customers to migrate to the new technology. An
integrated clicks and mortar strategy may be more effective than a spin-off when product
selection complexity is high and when retailers can leverage complementary brick and mortar
assets to provide superior customer service. The overall strategy should be designed to have
bricks and clicks coordinate closely in delivering value to customers. 

Pure plays have the opposite problem. Rather than leverage complementary assets, they
must figure out a way to destroy, free-ride on, or access the complementary assets of clicks and
mortar competitors. Internet-only competitors that do not develop an effective strategy for
destroying the value of brick and mortar assets will find it tough going in retail sectors
characterized by high product-selection and operational complexity. 

Understanding who will be successful in the online arena and how the changing market
affects Internet-only and conventional retailers will give companies the insight needed to gain
competitive advantages in the online marketspace. 

__

By Jeffrey H. Dyer & William Hesterly

End Notes 

  1. Fortune, 1 May 2000, 40.
  2. The Wall Street Journal, 23 October 2000.
  3. Christensen, Clayton & Michael Overdorf (2000). "Meeting the Challenge of Disruptive
    Change." Harvard Business Review, March-April, 67-76.
  4. Kelly, Kevin (1998). New Rules for the New Economy: 10 Radical Strategies for a
    Connected World. New York: Viking, 147.

About the Authors 
Jeffrey H. Dyer is the Donald Staheli Chair in International Strategy and an associate
professor in the department of Organizational Leadership and Strategy at the Marriott School. His research focuses on strategic alliances, e-commerce strategy, and interorganizational learning, knowledge management, and trust. Dyer taught at the Wharton School of Business at the University of
Pennsylvania for six years before coming to the Marriott School. He earned his PhD in
management strategy and organization from the University of California Los Angeles in 1993
and his MBA in 1984 and BS in psychology in 1982 from BYU.

William Hesterly is the Zeke Dumke Faculty Scholar and a professor of management in the
David Eccles School of Business at the University of Utah. His recent research focuses on the
effects of new technologies introduced in an industry on established firms and upstart attackers.
He received his PhD in 1989 from the University of California at Los Angeles in organization
and strategic studies and his MOB and BS in psychology in 1980 from BYU.

Related Stories

data-content-type="article"

How Will You Carry His Name?

March 26, 2024 08:30 AM
Drawing upon her experiences in the professional and academic worlds, associate professor Abigail Allen shares how followers of Christ can represent His Church.
overrideBackgroundColorOrImage= overrideTextColor= overrideTextAlignment= overrideCardHideSection=false overrideCardHideByline=false overrideCardHideDescription=false overridebuttonBgColor= overrideButtonText= overrideTextAlignment=
data-content-type="article"

Escaping the Hustle Culture

November 28, 2023 01:33 PM
Practical Tips for Finding a Healthier Work-Life Balance
overrideBackgroundColorOrImage= overrideTextColor= overrideTextAlignment= overrideCardHideSection=false overrideCardHideByline=false overrideCardHideDescription=false overridebuttonBgColor= overrideButtonText= overrideTextAlignment=
data-content-type="article"

Time for a Prep Talk

November 28, 2023 01:31 PM
Huddle up: the third and final piece in Marriott Alumni Magazine's preparedness series looks at community preparedness.
overrideBackgroundColorOrImage= overrideTextColor= overrideTextAlignment= overrideCardHideSection=false overrideCardHideByline=false overrideCardHideDescription=false overridebuttonBgColor= overrideButtonText= overrideTextAlignment=
overrideBackgroundColorOrImage= overrideTextColor= overrideTextAlignment= overrideCardHideSection=false overrideCardHideByline=false overrideCardHideDescription=false overridebuttonBgColor= overrideButtonText=