First Monday
When Internet Companies Morph: Understanding Organizational Strategy Changes in the 'New' New Economy by Robert J. Kauffman, Tim Miller, and Bin Wang

Abstract
When Internet Companies Morph: Understanding Organizational Strategy Changes in the 'New' New Economy by Robert J. Kauffman, Tim Miller, and Bin Wang
The rapid ascent of the Internet economy funneled almost $US90 billion of venture capital money into Internet startups over a period of four years that roughly ended in mid-2000. An equally rapid bust in the cycle that year abruptly shut off funding and thrust remaining Internet companies into an unprecedented frenzy of adaptive strategic and organizational re-focusing behavior. In this article, we relate the findings of our study of this period of hyper-evolution and give a snapshot of the publicly reported "morphing" activities of 125 Internet companies, based on which we propose a profitability-driven typology of Internet firm repositioning behavior. The study provides academic researchers with an overview of industry strategic mutation patterns and provides executives with a process analysis for identifying and evaluating their own strategies in a way that is essential for success in the highly volatile Internet economy. We also offer our predictions on these strategies' efficacy in light of the current emphasis on business profitability and return on investment (ROI).

Contents

The Beginning of the 'New' New Economy
Strategic Morphing and Sustainable Advantage
New Results on Strategic Morphing in the Internet Firm Marketplace
Understanding Morphing Strategies
Evaluating the Mutation Strategies of Internet Companies
Learning From the Morphing Strategies of Internet Companies
Conclusions

 

 

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The Beginning of the 'New' New Economy

The rapid ascent of the Internet economy followed by its equally rapid shakeout has set the stage for a period of business repositioning that is historic in both its scale and its speed. The now-failed magazine Industry Standard ( www.industrystandard.com) reported that from 1998 through 2000 private investors, in an attempt to capitalize on what appeared to be record growth rates of the Internet, poured more than $US90 billion into an estimated 7,000 to 10,000 startups while public investors drove Internet IPOs to stratospheric price heights [ 1]. Operating on assumptions that companies needed to operate on "Internet time" and spend big to grab market share at the expense of profits, investors placed large rounds of funding in Internet companies and instructed them to spend it quickly. Short-term profitability and return on investment (ROI) seemed to be far from the minds of the market leaders.

However, by the end of the first quarter of 2000, it had become apparent that most Internet companies would not produce positive cash flow in the near term, if at all. On 20 March 2000, Barron's published a luridly illustrated cover story entitled: "Burning Up - Warning: Internet Companies Are Running Out of Cash (Fast)" (Willoughby, 2000). The article suggested that 51 of the 207 Internet companies that were studied could run out of cash in the next 12 months. Shortly after stock prices for Internet firms started to plunge (Schiffman, 2000) and by the end of the year had taken the NASDAQ to its worst annual loss in 29 years and effectively shut down the IPO market; see Figures 1, 2, and 3.

 

Figure 1: The Extended Plunge of the NASDAQ Following 20 March 2000.
Source: BigCharts.com, July 10, 2002 (www.bigcharts.com)

 

 

Figure 2: Number of IPO Issues, NASDAQ-Listed Stocks, 1999-2001.
Source: www.nasdaq.com

 

 

Figure 3: Value of IPO Issuance, NASDAQ-Listed Stocks, 1999-2001.
Source: www.nasdaq.com

 

With IPO opportunities having largely shut down and market valuations for New Economy firms imploding, private equity investors abruptly closed their purses, leaving numerous Internet companies with shortfalls of operating cash and budgets that no longer matched their business ambitions in a rational market context. As a result, Internet companies abruptly began to curtail their spending, compounding the difficulties their peers were experiencing with raising money, since many Internet firms had been relying almost solely on the hype of the "digital Gold Rush" and the earlier market following that had built up.

These dramatic and sudden changes in the market climate forced many Internet companies into a period of readjustment to conserve cash, diversify their customer bases and more effectively focus on higher-return market niches. Those that have not been able to adapt to the tough market environment have been forced to exit, and the number of failed Internet companies now totals more than 800 firms, according to research reports by Webmergers.com (Webmergers, 2002).

In this study, we explore the spectrum of adaptive strategies employed by the Internet firms to cope with the economic slowdown in their sector, and the overall reorientation of market investors towards the 'new' New Economy. On the basis of our analysis of the strategic moves and business model reconfigurations of 125 electronic commerce-focused companies, as they have been reported in the major business and trade publications and through a variety of interviews conducted at Webmergers.com and the MIS Research Center at the Carlson School of Management of the University of Minnesota, we propose a process model for identifying and assessing Internet firm strategy "morphing" behavior. In addition, we also provide our thoughts on how likely different strategies will work out for these firms. The results from the current study can help academic researchers understand the diverse strategies Internet companies use to improve the sustainability of their competitive advantage in the context of fierce market competition. In addition, business professionals, especially managers of Internet-focused firms, can use our process model to evaluate the alternatives that remain available to them, so they can identify a strategy that generates higher payoffs.

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Strategic Morphing and Sustainable Advantage

We draw upon the literature on evolutionary game theory (Maynard Smith, 1982; Samuelson, 1998; Weibull, 1997) as the theoretical background of the current research. Evolutionary game theory tackles the dynamics of evolution in biological populations, and is motivated by such referent disciplines as population biology and genetics, as well as by economic analysis of markets and the firms that compete with them. Evolutionary game theory treats how individuals in a population learn through a trial-and-error process, and explains why certain species survive the process of natural selection in their competitive environments, while others do not.

Two prerequisites for the selection process are the limited resources that are available in the environment and the individual differences that occur among competing members of the population. The former determines that some individuals in the population will survive while others will become extinct. The latter indicates that there may be different capabilities for adaptation that occur within populations in a competitive environment. Together, they determine that only those that are the fittest will be able to survive. In the evolutionary process, individuals (and firms) can also learn by a process of trial and error which strategies they apply generate higher payoffs. Consequently, they can adjust their strategy in the competition with others and enhance their chances of survival.

We equate this organic view of market competition and natural selection among "species" to what we have been observing the last couple years in the competition and market shakeout among companies in the Internet economy. There are differences among Internet companies in aspects such as industry, products, customers served, management teams, market niche specificity, and capacity to continue raising capital. There are also differences among Internet companies in terms of the "ripeness" of the sector in which they compete. By ripeness, we mean the relative readiness of a market to accept a product or service. The limited numbers of customers, suppliers, and financial resources determine that only those companies that have been best positioned for the rough and tumble competition have been able to survive. Indeed, to continue our analogy: an Internet firm's adaptability to the 'new' New Economy is determined by its "competitive genetics." These include the unique value it provides to its customers, its relative costs compared to its competitors, the quality of its market niche relative to more traditional reintermediating firms, and its financial strength. A company that can stay on top of the competition in these aspects is in an advantageous position to its competitors and is more likely to succeed [ 2].

The trial-and-error learning process that evolutionary game theory suggests as a possible interpretation of the manner in which firms compete in the marketplace is crucial to our understanding of the strategy morphing behavior that we have seen many Internet companies firms engage in. Strategic mutation to the organizational business models of these firms occurs through purposeful, intentional changes that reflect a firm's adaptability to its marketplace in competition with other businesses. However, strategic mutation may also reflect almost random actions with organizational strategy (or at least some that are not very well conceived), permitting firms to observe the feedback that the market has to offer (in market share, revenue, funding capacity, etc.). Through this process, firms will come to realize which strategies will put them in an advantageous position with respect to competition with their rivals, access to capital markets and top notch human capital, and so on, and permit them to update their strategies accordingly.

GartnerG2 ( www.gartnerg2.com), a research division of Gartner Group, proposed a strategy model that is similar to the process that we find analogous to the thinking that is associated with evolutionary game theory (Rountree, 2001). A firm exists in both external and internal environments, learning to acquire knowledge by scanning and sensing these environments. In addition, a firm also innovates and adapts, which allows it to further accumulate new knowledge. This constantly updated knowledge base further powers a firm through activities such as mutation and strategic change. Using this rough script of the process GartnerG2 depicts the rich process through which firms learn to achieve higher performance by mutation.

Evolutionary game theory provides a high level framework for understanding the Internet firm strategic morphing process. We next present the results of our case study analyses and propose a classification of strategic morphing behaviors that appears to characterize well what we have observed in the Internet company marketplace. Instead of focusing on the whole process as evolutionary game theory does, however, we take snapshots of the morphing behavior we observe when Internet companies change their strategies to achieve a better fit with the marketplace. It is worth noting that since our observation period is the early stages of the Internet firm strategic morphing process, our categorization of the morphing strategies is specific to firms in the early e-commerce life cycle. As e-commerce firms mature, the morphing we may observe might be different or less dramatic. However, as evolutionary game theory points out, mutations still occur as the competition in the marketplace goes on. Our discussion of the case study findings, and our classification of the observed morphing behaviors sets up our subsequent proposal for a framework that enables us to extend our interpretation from description to prediction, and to offer normative guidance to managers who are faced with problems with their firm's business model or organizational strategy that requires an evolutionary approach to increase the likelihood of firm survival.

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New Results on Strategic Morphing in the Internet Firm Marketplace

This research is based on a set of industry and organizational mini-case studies that are drawn mainly from published articles in business and trade publications. Given the number of cases and the diversity of published sources from which we drew, we believe the results of this research provide a reasonably representative picture of the strategic mutations that characterize the Internet company market during the last couple years.

Research Method

Case study research is known to provide an excellent means for supporting the exploration for new theoretical perspectives on problems that are of interest to managers (Benbasat et al., 1987). In the earliest stages of the research process with respect to an issue or problem area that has not been studied to date, it is important for the researcher to ground himself or herself in the real world aspects of the problem to ensure that an appropriate understanding of the actual problems for research can be reached, and that the perspectives that are developed along the way add value to the stakeholders for the work.

Our research approach takes advantage of case study methods to develop an understanding of the strategy changes of Internet firms. The work does not involve survey methods, in that no questionnaires were mailed to corporate executives, nor were there any online opinion polling or consistent interviewing tactics that were applied to a targeted population of respondents. As such, the findings are not the result of a "random" survey. If we had taken this approach, then we would be reporting on many Internet companies that failed to be nimble or adaptive enough to sustain their place in the market, and are no longer in business today. This, of course, would not have been possible. Nor are our findings a by-product of many in-depth interviews. Indeed, for some of the firms that figure in our data set, it would have been difficult to carry out interviews with corporate leaders in times so difficult as those we have seen, since many potential respondents would have been "on the street" again, looking for new entrepreneurship opportunities where venture capital funding has remained available.

Instead, similar to Subramani and Walden (2001) who developed a database of articles on corporate announcements related to e-commerce, we built a database of several hundred articles that profile individual Internet companies or address the strategy changes of one or more firms in an industry cluster. Most of these articles were published in 2000 and 2001 in business or trade publications, such as the Wall Street Journal, Business 2.0, BusinessWeek, Industry Standard, New York Times, and other similar publications. After initial rounds of reading the articles, we developed a set of potential categories that could be used to classify the various business model change strategies that were represented. Further refinement of the initial set of categories led us to assign each company that was represented in the data set to one or more of those categories. Since some of the firms made multiple changes and adjustments during the period of study, we assigned several companies to more than one category.

Morphing Strategies: A Five-Category Classification

We identify five broad categories of strategic morphing behavior that Internet companies have employed. They include changes in product and service offerings, changes in customers, adjusting pricing model, establishing offline presence, and other strategies. Table 1 provides a summary of the firms we examined in terms of these categories.

A majority of the repositioning strategies take the form of market and product offering changes. Some have shifted to the application service provider (ASP) pricing model. Market repositioning emphasizes the most profitable customers, either from B2C to B2B or upstream within the B2B sector. Expand or contract product and service offerings include both expansions and narrowing of offerings. To increase revenue, companies also make pricing model adjustments. Some have made adjustments to a fee-based model, for example, shifting from individual product pricing to bundle pricing, or waiving certain fees if a business volume criterion is met. In addition, some pure-play Internet companies in our sample also realized the importance of an offline presence, and expanded their business model to incorporate non-Internet-based operations to match their e-commerce capabilities. These strategies often take the form of e-commerce adjustments to the bricks-and-mortar model for business, enabling firms to penetrate the markets associated with the traditional media.

 

Table 1: Internet Firm Strategic Mutations, 2000-2001.

Description of Strategic Mutations
Count
Percent
Change Product/Service Offerings in Existing Markets
    
Shift to application service provider (ASP) business model
10
8
Expand product/service offerings
17
14
Refocus and narrow product/service offerings
17
14
Move Upstream to New Higher Quality Customers
    
Expand or shift from B2C to B2B
42
34
Expand or shift upward in B2B markets
12
10
Adjust Pricing Model
    
Make adjustments to the fee model
7
6
Pursuing Offline Presence
    
Adopt bricks & mortar strategies
9
7
Adopt traditional media model
11
9
Other
12
10
Total Number of Companies in Sample [3]
125
  

 

To what extent are these changes consistent across business-to-business (B2B) and business-to-consumer (B2C) e-commerce? We define B2B firms as Internet companies that have other companies as their direct customers, and B2C Internet companies as those having consumers as their direct customers. This is similar to the definition Subramani and Walden (2001) used in classifying B2B vs. B2C e-commerce initiative announcements. It turns out that both the B2C and B2B sectors have used an upstream migration strategy in search of higher quality customers. The most common and most visible strategic direction change has been among B2C companies that have adopted what we call the "B2C2B morph," a strategy employed by 42 of the 95 companies in our sample. This approach typically involves a firm that was founded as a B2C e-commerce product or services provider, which then works towards broadening its target market into the B2B marketplace, which has been shown to be far richer in terms of potential revenues for the firm. Table 2 provides an illustrative breakdown of the various strategies for B2C and B2B Internet companies.

 

Table 2: Internet Firm Mutation Strategies By Sector, 2000-2001.

Description of Strategic Mutations
B2C Firms
B2B Firms
 
Count
Percent
Count
Percent
Change Product/Service Offerings in Existing Markets
        
Shift to application service provider (ASP) business model
0
0
10
29
Expand product/service offerings
7
8
10
29
Refocus and narrow product/service offerings
15
17
2
6
Move Upstream to New Higher-Quality Customers
        
Expand or shift from B2C to B2B
42
47
N/A
N/A
Expand or shift upward in B2B markets
N/A
N/A
12
34
Adjust Pricing Model
        
Make adjustments to the fee model
6
7
1
3
Pursuing Offline Presence
        
Adopt bricks & mortar strategies
6
7
3
9
Adopt traditional media model
11
12
0
0
Other
8
9
4
11
Total in Sample [4]
90
  
35
  

 

However, as Table 2 also demonstrates, a similar proportion of B2B companies - 12 of the 35 reviewed - also shifted their focus upstream, moving from one class of business customer toward better-heeled prospects in the Fortune 1000 or other larger enterprises with larger spending budgets for technology services. Overall, we found that B2C firms were more likely than B2B firms to tighten and refocus their offerings, in many cases to cut out low-margin products or focus on a niche, thereby reducing the enormous marketing costs involved in addressing broad consumer audiences.

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Understanding Morphing Strategies

In this section, we go into greater detail on these strategic moves and discuss their applications by the companies in our sample.

Adjusting Product Offerings for an Existing Customer Base

Many Internet companies have adjusted their product mix to renew revenues that have fallen off sharply since Spring 2000. Several online marketplaces and electronic exchanges moved from a transaction model to an ASP business model to provide private exchange services to an increasing number of businesses that desire such services. In addition, our case study evidence shows that about the same number of companies expanded or contracted and re-focused their product and service offerings. Expansionist strategies appear to have been designed to grow revenue-per-customer and to differentiate an Internet firm from its competitors by increasing the breadth of its product line. Product-focusing strategies, on the other hand typically stripped down the product line to core offerings in an attempt to eliminate low- or no-margin products, to stem the cash hemorrhage, differentiate the brand, and accelerate profitability.

Moving Upstream to Address a More Profitable Customer Base

By far, the most popular repositioning action involved a "flight to quality" in the customer base targeted. In the B2C sector, many companies cut back on their marketing expenditures and addressed deeper-pocketed business customers by extending or shifting their product and service offerings from consumers to business clients in what has become to be known popularly as the "B2C2B strategy." Companies that already targeted the B2B market in their product or service niche also tended to move upstream. The most typical switch in focus was away from the once-wealthy Internet companies to more established corporate names or the Fortune 1000 market.

Adjusting the Pricing Model

Another set of Internet companies developed new revenue models in an attempt to better monetize their existing customers. They made adjustments to the fee model that they used.

Pursuing an Offline Presence

Many bricks-and-mortar enterprises are deploying Internet technologies to stay competitive. However, the real pressures in the marketplace are focused on former pure-play Internet companies that have now shifted their resources to explore how to leverage bricks-and-mortar capabilities to make their own business models more attractive, and target and better serve new customers. In some cases, the firms have even sought to retrofit their core businesses by de-emphasizing their Internet capabilities somewhat to distinguish themselves from other Internet market competitors. We have seen this occur in two prototypical forms. Let's consider each in greater detail.

Other Actions

Although the above categories reflect the most common adaptive strategies, Internet companies have deployed other maneuvers that may be of interest to other companies. Some other strategies include:

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Evaluating the Mutation Strategies of Internet Companies

Earlier in this article, we reported on the range of approaches that Internet-focused firms have been applying in their strategic morphing process. But how effective will their maneuvers and adjustments be? Are Internet companies able to leverage these strategies to obtain sustainable competitive advantage in their markets? How can a company pinpoint the appropriate mutation strategies it should carry out, given the variety of possibilities? Does morphing under duress lead to a different likelihood of success than when the strategy adjustments are made with financial resources in hand? In this section, we propose a process analysis for mutation strategy evaluation. We emphasize the importance of finding strategic mutations that can provide a company with sources of sustainable competitive advantage over its competitors. We apply our proposed model to two Internet companies, Britannica.com and BlueLight.com, to illustrate the process analysis that we advocate. However, we also note that in the New Economy sector, the reality has been that many firms are forced to undertake "pain morphing" to be able to avoid bankruptcy. And so, the reader should recognize that our evaluations apply with special relevance to the recent developments in the marketplace, where scarcity of capital resources has put many Internet companies into panic model.

How should we as observers evaluate the effectiveness of the morphing strategies we observed in the electronic marketplace? We adapt an approach for evaluating Internet company strategic mutations on the basis of a more general decision framework proposed by Shaw (1990) to enhance organizational effectiveness in strategy selection among service industry firms. Shaw uses a multiple-module process to illustrate the steps a service firm should go through to identify the directions for its strategic change. In this analysis, the author asserts that a firm should first evaluate its status relative to its competition in the marketplace. Then it should identify the directions for change. Thereafter, the firm should finalize the implementation details of the strategy. In this section, we propose a similar process analysis through which we can evaluate various morphing strategies that an Internet firm may undertake in order to identify the most appropriate ones. This process analysis can also be used internally as Internet companies try to identify and select among different strategic mutations. See Figure 4.

 

Figure 4: A Process Analysis for the External Evaluation of Internet Firm Business Model Changes.
Source: Adapted from J.C. Shaw, The Service Focus: Developing Winning Game Plans for Service Companies. Homewood, Ill.: Dow Jones-Irwin, 1990.

 

The first question we need to answer is: What is the nature of the business? That is, which markets does the company serve and what is its primary value proposition to its customers? As Porter (2001) points out, delivering unique value to its customers is critical to an Internet company's long-term survivability. With a keen understanding of its business, a firm can direct its limited resources available toward the efforts that bear strategic significance. We expect this to be a critical step, even for Internet companies that are forced into "pain morphing" mode. Getting the answer to these questions right will be the basis for longer-term business strategy solutions.

After determining the answers to this starting question, the second step is to assess the Internet-focused firm's position in the marketplace in competitive terms. Who are the current and prospective competitors that may enter the Internet marketplace? Will they be other Internet companies, or will they be traditional firms that develop new Internet-focused strategies? In light of competition from these kinds of firms, what are the company's strengths and weaknesses compared to its rivals? Is it resistant to being disintermediated by other firms that can achieve direct links with the customer? Or is there another firm that can achieve a more effective product or service portfolio? Developing answers to some of these questions will help the company to prepare to identify directions in which to adjust its business model.

In the third step, we should try to pinpoint the focus of the Internet firm's intended business improvements. For this part of the process, we emphasize the importance of a forward-looking perspective. When the company's interest to morph its strategy is due to some form of duress, the emphasis on long-term positioning remains critical. In addition, the rate of change in the technology and Internet sector has been so rapid, that any assessment of process, product or service improvements must be made with a sense of what else is technologically possible in the near-term, market-wide. Thus, it is important for the company not only to examine the current market competition, but also to foresee future market trends and prepare itself early for the range of future challenges that are likely to arise. In this respect, considerations of the possibility of digital convergence, competitive threats that may be mounted by other firms that have the potential to mitigate the beneficial impacts of a firm's business improvements, are important.

After deciding on the general nature of the strategy changes to be made, the next step is to choose the set of actions that can take the firm there. At this stage, we should evaluate the efficacy of potential strategies and their possible outcomes in greater detail. Porter (2001) examined the recent turbulence in the electronic marketplace and called for a "return to fundamentals." He argued that a firm is more likely to benefit from adopting strategies that can lead to sustainable competitive advantage over its rivals. Porter also emphasized that Internet technologies were no different from the traditional technologies in this aspect. So an Internet company can only reap the benefits of an advanced technology if the technology puts it ahead in the competition with other businesses. As a result, we emphasize in our process analysis the importance of identifying potentially sustainable competitive advantages that can be achieved through strategic mutation. After scanning the spectrum of possibilities, a company should select among the business model and strategy changes that are most likely to provide it with sustainable competitive advantage over its competitors. In addition, the foregoing analysis may turn up other firm needs to acquire certain strategic necessities (Clemons and Kimbrough, 1986) that are critical for the firm to remain in the competition even if there is no sustainable competitive advantage that develops.

The final step related to evaluating strategic mutations is outcome evaluation. We can compare the intended strategic plan based on our process analysis with the actual plan the Internet company carried out. If they are the same and the market feedback is less than desirable, we need to identify possible reasons for the outcome, and what should be done to make further changes to the firm's strategy to be better able to deliver business value. If the actual and the recommended strategies are different and the strategy taken did not result in the expected outcome, the Internet firm might have selected the wrong strategic direction, wasting its resources in the process. More generally, we expect that this, like all strategic planning, should be an iterative process.

Next, we consider two examples of firms from the New Economy sector, Encyclopedia Britannica Online and BlueLight.com. We use them to illustrate how we can use our five-step process analysis to understand the efficacy of different strategy mutations.

Encyclopedia Britannica Online

The reference king, Encyclopedia Britannica Inc., first launched a Web-based product, Encyclopedia Brittanica Online ( www.eb.com), in 1994. The purpose of establishing Encyclopedia Britannica Online was to provide institutional and individual users with access to the complete content of the print edition of Encyclopedia Britannica (Disabatino, 2001). Since that time, Encyclopedia Britannica Online, which initially was developed as a subscription service, has reshaped its online strategy three times. Analyzing some of the strategic mutations to Britannica's business model on the Internet offers a useful illustration of the application of our evaluative process for strategic mutations.

Q1: What is the nature of the Internet firm's business?
The encyclopedia business has been traditionally targeted at the reference and educational market when only print editions were available. This market has exhibited consistent demand over time for encyclopedias with an extensive coverage of diverse topics and has not been very price-sensitive. As an authoritative reference publisher with a history of more than 200 years, Encyclopedia Britannica had a solid customer base of educational institutions such as schools and colleges. Enabled by advancements in information technology, encyclopedias that are now published on CD-ROM, DVD and the Internet have drastically reduced production costs and made inroads into the consumer market, which prefers satisfactory coverage at an affordable price.

Q2: Where does the Internet firm stand in its markets?
With the entrance of other companies into the digital reference market in late 1980s, especially Microsoft (which began to offer its own product bundled with its operating system), Encyclopedia Britannica experienced a significant drop in sales volume. The aggressive pricing of Microsoft's Encarta reference series attracted the consumer market and enabled Microsoft to obtain a significant market share. As a result, Encyclopedia Britannica was forced to redirect its revenue-generation efforts, and began to develop strength by building on its customer base in the educational market. It continues to face competitive weakness that it has yet to overcome in the consumer market.

Q3: Where should the Internet firm improve its position?
Encyclopedia Britannica's competitive advantage over Microsoft has lain in its institutional market. To maintain its success, it must continue to focus on this market to preserve its market leader position. In addition, to recapture its lost market share to Microsoft, Encyclopedia Britannica should develop another version of its contents on the Internet to cater to the demand of the consumer market.

Q4: What strategies should the Internet company take?
In developing two versions of its encyclopedia to meet the needs of the two markets, Encyclopedia Britannica should differentiate the two products. This way, the company will not be cannibalizing its sales in the institutional market by providing a much more affordable consumer version, and institutions will find that paying a higher subscription fee for the more extensive contents can be justified.

Q5: How should the Internet firm's implementation and outcome be evaluated?
In October 1999, Encyclopedia Britannica Inc. launched Britannica.com ( www.britannica.com) as a separate corporate entity using an advertising-supported model with the aim of broadening its market beyond an institutional-heavy customer base. It offered the full text of the Encyclopedia Britannica free of charge, selling instead a high-end version supplemented with bonuses, including in-depth features and integrated searches. Within a couple of months, however, the Web site was repositioned by the firm as a portal, buttressing its reference data with free original content, as well as stock, news and sport information. The primary intent was to ramp up advertising sales (Useem, 1999). Now, as Internet ad dollars dwindle, the company is refocusing on its core business - reference content and education - and returning to a two-tiered pricing model with the some basic content free and the complete version for a subscription fee (Disabatino, 2001). In 2001, Britannica.com also launched a fee-based Web site called Britannica School ( www.britannicaschool.com), which is especially packaged for students and teachers (Britannica.com, 2001).

Providing its entire content at Britannica.com for free endangered its competitive advantage in the educational market. With such content freely available on the Web, educational institutions find it more difficult to justify paying a high subscription fee. Moreover, the redirection toward a portal site also conflicted with the reference authority image that the company built up over the years. As Porter (2001) pointed out, competition based solely on price would only ignite a price war and was ultimately destructive. Instead, the key to success is to provide unique value to customers so that a firm can take advantage of their willingness-to-pay. In the case of Britannica, even if the advertising market were still strong, its decision to adopt a free pricing model still would not allow the company to build upon its strengths and sustain its competitive advantage in the educational market. Thus, compared to these strategies, Britannica's return to a subscription model and the launch of Britannica School are more in line with its core competencies and competitive advantages.

BlueLight.com

After its initial attempts to launch a Web site failed in 1998 and 1999, Kmart teamed up with Yahoo! and SOFTBANK Investment Capital and launched BlueLight.com ( www.bluelight.com) in December 1999 (Davis, 2001; Kaufman, 1999). Later, BlueLight.com went though a couple of relaunches and a series of strategic mutations in trying to compete with Wal-Mart, Target, and their online sites.

Q1: What is the nature of the Internet firm's business?
BlueLight.com is the online shopping site for Kmart, which has competed as a discount retailer. It offers products in categories such as electronics, computer, home, jewelry and toys. BlueLight's value proposition to its customers has been the convenience of Internet shopping at a reasonable price. In addition, the company also offers the Martha Stewart product line, which is widely known to be available at Kmart.

Q2: Where does the Internet firm stand in its markets?
BlueLight and Kmart's competition have come from their two rivals in the discount retailing sector, Wal-Mart and Target, and their respective online shopping sites. Over the years, Wal-Mart has built an image of a low-price leader and maintained a tight supply chain that has allowed it to minimize its operational costs. Target's focus has been on a somewhat more upscale consumer market. Even though it does not always post the lowest prices, Target provides shoppers with a nice shopping environment and more product variety. In contrast, Kmart has failed to portray a clear image to the consumers, though its strategy with BlueLight was intended to help the company differentiate itself.

Q3: Where should the Internet firm improve its position?
Kmart failed to portray a distinct image to its customers and differentiate itself from Wal-Mart and Target. It has not had as efficient a supply chain as Wal-Mart, nor has it focused on developing a shopping environment to make itself more appealing to higher income consumers. However, Kmart and BlueLight's potential advantage could have come from exclusive merchandising arrangements, such as with the Martha Stewart product line and others (Gaffney, 2002). By building an image of a provider of high quality home furnishing merchandise, Bluelight.com could have been able to develop a loyal customer base, which could have been a source of sustainable competitive advantage.

Q4: What strategies should the Internet company take?
Strategies that Bluelight.com can take include providing a direct link to its Martha Stewart department at its homepage, and make shopping in this department an easy and pleasant experience. To establish an image as a discount retailer with unique product offerings, Kmart and Bluelight also can launch cross-channel advertising campaigns to make consumers more aware of their exclusive merchandise. In addition, to improve the stickiness of the Web site, BlueLight can also provide helpful tips for home decoration such as "Martha Stewart Tip of the Day", which can also help the company to promote its product lines.

Q5: How should the Internet firm's implementation and outcome be evaluated?
Gallanis (2000) reported that there were five key elements in BlueLight's strategic plan:

Now when we examine the strategies that BlueLight has employed, we see that even though they were intended to provide the firm with a competitive edge, there were few elements that made for sustainable advantage. For example, BlueLight's easy-to-use Web site and broad product selection are two strategic necessities for competition; they have not been sufficient to give BlueLight a competitive edge over its primary rivals, WalMart and Target, however. The synergy between the bricks-and-mortar channel and online stores could provide the company with a competitive advantage over pure-play online discount retailers, but not over Wal-Mart and Target, who also have had very strong offline presences. Instead, these strategies only provided the necessary conditions for BlueLight to compete in the digital marketplace.

To become a "great" online shopping site, BlueLight had to turn to other strategies that are sources of sustainable competitive advantage. A loyal customer base is one such example. By motivating its bricks-and-mortar shoppers to go online and by developing brand loyalty programs, BlueLight might have been able to enjoy a steady source of revenue from its repeat customers. In addition, the expansion of the Martha Stewart Everyday and the Disney stores at BlueLight.com (BlueLight.com, 2001c) had the potential to help the company to build a loyal customer base and differentiate itself from Wal-Mart and Target. Recent events have overtaken BlueLight's efforts to morph, however. Its parent, Kmart filed for Chapter 11 bankruptcy protection on 22 January 2002, and is currently undergoing a major business reorganization.

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Learning From the Morphing Strategies of Internet Companies

In the previous sections, we discussed the morphing strategies that Internet companies employ to achieve a better strategic fit with their highly competitive marketplaces. We also proposed a process analysis which can be used to evaluate these strategies. In this section, we offer our thoughts on the likelihood that these strategies will improve an Internet company's position in the competitive landscape.

During the early days of market hype around Internet firms, when financial capital could be easily extracted from the capital market, many entrepreneurs viewed the Digital Economy as a revolution and equated innovative ideas that were surfacing around new applications of IT with the potential for future success. With goals of growing scale size as quickly as possible and capturing a significant market share, many of these firms expanded without a sound game plan and made fraught-with-risk attempts to achieve a critical mass by pricing below their costs. We now know, of course, that most Internet companies were unable to sustain their operational growth and fast-burn cash consumption. Many turned to employ some of the morphing strategies we discussed earlier to improve their survivability. But, are these strategies likely to work out for them in the long run? Does strategic morphing change the overall likelihood of survival? If this is not the case generally, then what about in specific instances and with specific kinds of business model changes? Unfortunately, the answers are not so straightforward.

As Mahadevan (2000) pointed out, there are three elements to a business model: the value stream, the revenue stream, and the logistical stream. The value stream is the firm's value propositions to its customers. The revenue stream refers to the firm's source of income. The logistical stream emphasizes the channel management and product and services distribution aspects, and where the firm places itself along the supply chain. It is helpful to use an example to understand the relevance of these elements, as we think about the efficacy of business model changes.

Covisint: The Automotive Industry E-Procurement Specialist

We consider an Internet-based intermediary in B2B e-commerce, the automotive manufacturers' e-market, Covisint ( www.covisint.com), as an example. Covisint's core value propositions for buyers include reduced search costs, possibly reduced prices due to aggregated demand in a single market, and an ability to control the general workings of the marketplace. Sellers, meanwhile, benefit from being hooked up in the focal market for automotive manufacturers' purchases, and also can take advantage of reduced search and operational costs, since interorganizational information systems standards are set for the marketplace. Its revenue stream as a captive, but third-party electronic markets operator materializes from the exchange of supply information and the demand for transactions services from buyers and suppliers. There probably is a high willingness-to-pay among participants for Covisint's services, since it aims to streamline supply chain operations beyond what was available before. The logistical stream in this context emphasizes the manner in which trade settlements and economic exchange are finalized, so that the appropriate goods are available for use in manufacturing operations where they are demanded.

Among the three streams, Mahadevan argued that value stream is the most important and it is crucial to a firm's long-term survivability. The reason is that a firm is only able to survive if it delivers value to its customers. Porter's (1985, 2001) theory of sustainable competitive advantage further informs us that a firm has to deliver unique value to its customers to survive, and companies doing business on the Internet are no exception. As a result, in trying to predict the efficacy of Internet companies' morphing strategies, we argue that the company has to have a value stream, i.e., a unique value proposition. Otherwise, no matter what strategies the company embarks on, it is not far away from failure. This appears to the case with Covisint, and other similar intra-industry e-markets that are built by a coalition of major firms in an industry that could not construct solutions of similar quality by themselves.

Flooz.com: Electronic Money for Affinity Marketing and Corporate Rewards Programs

Another interesting example that we have tracked is Flooz.com ( www.flooz.com, now in bankruptcy), which has not enjoyed as much success as Covisint. Flooz.com started as a B2C online currency site. Bringing electronic money solutions to the Internet has proven to be a difficult business, as industry startups such as E-Cash Technologies (www.ecash.com, and the now-failed Digicash), iPin ( www.ipin.com), Digital Equipment Corporation and Compaq Computer Corporation's Millicent ( www.millicent.com) have shown. In Flooz.com's case, consumers could purchase "Flooz dollars," a form of electronic currency, and spend it at specific stores in a network of connected firms. The company's initial plan was to facilitate the use of Flooz dollars for gift giving. Even though Flooz.com kept working towards building Flooz dollars' acceptability at Internet stores, signing up online stores to accept proved to be difficult. At the height of the firm's presence on the Internet, Flooz.com's currency could be used at about 60 online stores, many of which were sites with relatively less traffic that were themselves looking for way to built a following. As a result, a consumer had a limited set of choices when she wanted to spend her Flooz dollars.

After experiencing difficulties in the consumer market, Flooz.com chose to morph its e-commerce strategy, turning to the corporate rewards market, thus moving upstream from B2C to B2C2B. A closer examination of Flooz.com's business model reveals that the company failed to provide a unique value proposition to customers on the corporate side. That marketplace, already crowded with brand-name corporate affinity marketing service providers, was no easier to compete in. As a result, it became clear that Flooz.com failed to offer a unique value proposition in any viable marketplace. The limited acceptance of the Flooz currency unrealistically constrained its value to consumers and other companies using Flooz as employee appreciation rewards. In addition, the cumbersome task of integrating Flooz as a method of payment and the commission Flooz.com charged also reduced online stores' incentives for accepting Flooz at their sites. With other forms of currency available, Flooz.com was not able to make additional headway, and filed for bankruptcy in August 2001 (Flooz.com, 2001). See Figure 5.

 

Figure 5: A Dead-End Morph: Flooz.com's Recent "New" Home Page on the Internet

 

Final Thoughts: On the Efficacy of Morphing Strategies

How likely is it that morphing strategies will work out for Internet companies that do deliver some sort of unique value? Under the current conditions of economic slowdown, strategies that help New Economy firms to improve their core businesses are the most likely to pay off. This is typically the case for traditional firms in times of recession. Thus, the focus will need to be on profitability and return on investments, instead of growth and critical mass as before. In fact, among the many Internet companies that have yet to achieve critical mass in the marketplace, probably those that focus on niche markets are most likely to benefit from strategies that help the companies to redefine their core business, reduce the number of their total product or service offerings, and focus on their operational support. These strategies will help Internet firms to sharpen their value propositions and improve profitability. Once they begin to achieve profitability, Internet companies can try out other strategies that involve expansion. But unlike before, the market will force them to do so with more of a blueprint. For the market leaders, product and service expansion strategies are likely to be more viable. However, we still recommend caution in executing these plans since they are often expensive and risky, and senior management can exert little control over changes in the economy that would lead to more favorable conditions for profitability.

Finally, we want to point out the importance of time as a key aspect of whether morphing strategies will succeed or fail. As we pointed out earlier, many of the companies that we have reviewed did not have the luxury of time to see their strategies mature. The market simply was changing too fast around them to afford them the time to see whether some of the original strategies they selected and other strategies they chose along the way that didn't work out as planned (e.g., BlueLight.com) could have worked given enough time.

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Conclusions

In this research, we conducted case studies of 125 Internet companies and categorized their strategic moves. Even though market expansion strategies, such as expanding product offerings and penetrating into the bricks-and-mortar world, are present in the strategic moves taken by the Internet companies in our sample, the general trend is a change in the generic characteristics that relate to the bottom line. The new emphasis is business profitability and ROI. No longer do we see any "blind" market expansion strategies similar to what we observed prior to the tech stock value shift in the stock market in March 2000. With the market turndown, shifting demand in the economy, and ever more difficult access to the capital markets, the Internet-focused firms have had to slow down their "cash burn" rates and focus on the long-term survivability of their businesses. In evaluating their strategic mutations, we have emphasized the critical role of obtaining sustainable competitive advantage. An Internet company should focus its efforts on strategies that it can use to distinguish itself from its competitors, such as delivering unique value to its customers and building a loyal customer base.

The contributions of our research are twofold. First, based on our results, academic researchers can better understand the different strategies Internet companies have taken to adapt to fiercer market competition and the economic slowdown. Second, business professionals, especially Internet firm executives, can use our process analysis to both externally evaluate and internally identify directions for strategic mutation and the strategies that can be employed. End of article

 

About the Authors

Robert J. Kauffman is Co-Director, MIS Research Center, and Professor and Chairman of the Department of Information and Decision Sciences at the Carlson School of Management, University of Minnesota. His doctorate is from Carnegie Mellon University, and he has held faculty positions at New York University and the University of Rochester. His research interests center on senior management issues in IS, organizational strategy and technology, e-commerce, and IT in various services industry contexts. His articles on IS and e-commerce issues have appeared in leading academic journals, and he was recognized four times recently with best-of-conference awards (WITS 1999, AMCIS 2000, ICIS 2000) for his work on strategic pricing in e-commerce and IT infrastructure investment decisionmaking.
E-mail: rkauffman@csom.umn.edu

Tim Miller is president of Webmergers.com, a hub for buyers and sellers of technology properties. Webmergers.com provides information, analysis and buyer-seller matching services for acquirers and sellers of Web properties and maintains a database of more than 3,000 technology M&A transactions. Prior to establishing Webmergers in 1999, Tim Miller spent five years as President of New Media Resources, a consulting firm to interactive media startups. Before starting New Media Resources, Miller spent five years in corporate development at Ziff Communications Co., assisting senior management in acquisitions research, strategic planning and development of online products. Before that, Miller studied interactive services in a fellowship at the Gannett Center for Media Studies at the Columbia University in New York. Miller has written a number of articles on interactive media, serves on the program committee of the MIT/Stanford Venture Laboratory and has chaired several national conferences on Internet M&A topics.
E-mail: tmiller@webmergers.com

Bin Wang is a third year doctoral student in Information and Decision Sciences at the Carlson School of Management of the University of Minnesota. She has a Master of Science in Retail Management from Purdue University, and is a past graduate of Renmin University in Beijing, China. Her research interests focus on electronic commerce, the analysis of electronic marketplaces and the new business models of the Internet, and the applications of theory and methods from marketing science and economics. Her empirical study of the performance of MobShop.com's group-buying mechanism was recognized as "best paper" in the Economics and Electronic Commerce Mini-Track at the Hawaii International Conference on Systems Science in Maui, Hawaii in January 2001. Her work also has appeared in the Journal of Management Information Systems. Her most recent publication is "Bid Together, Buy Together: On the Efficacy of Group-Buying Models in Internet-Based Selling," In: P.B. Lowry, J.O. Cherrington, and R.R. Watson (editors). Handbook of Electronic Commerce in Business and Society. Boca Raton, Fla.: CRC Press, 2002.
E-mail: bwang@csom.umn.edu

 

Acknowledgments

We would like to thank Hui Peng, Eric Walden and the corporate participants of the MIS Research Center Seminar for their helpful comments and suggestions on prior versions of this paper. The involvement and support of Webmergers.com has also been an important asset to this work, for which the University of Minnesota authors are grateful to have obtained.

Please direct comments about this paper to bwang@csom.umn.edu.

 

Notes

1. For details of the many IPO deals that have been offered in the past few years, we refer the interested reader to VentureReporter.net at www.venturereporter.net.

2. By the same token, this is made all the harder in a very "green" market. Consider the case of digital entertainment companies that faced such a market for their products. They ran into difficulties because broadband telecommunication capabilities failed to materialize in the marketplace. Thus, we view this as an issue of timing: both market timing and the amount of time the company has to meaningfully penetrate its marketplace before running out of cash.

3. Total firm count exceeds 125 and percentages sum to more than 100 percent because some companies deployed multiple strategies, and hence, are counted two or more times.

4. Some companies deployed multiple strategies; as a result, five were counted in both the B2B and B2C categories.

 

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Editorial history

Paper received 9 May 2002; accepted 14 June 2002.

Contents Index

Copyright ©2002, First Monday

Copyright ©2002, Robert J. Kauffman

Copyright ©2002, Tim Miller

Copyright ©2002, Bin Wang

When Internet Companies Morph: Understanding Organizational Strategy Changes in the 'New' New Economy by Robert J. Kauffman, Tim Miller, and Bin Wang
First Monday, volume 7, number 7 (July 2002),
URL: http://firstmonday.org/issues/issue7_7/kauffman/index.html