Applicability Of Generic Strategy (strategic Management)

Journal of Management 2004 30(5) 569–589

The Applicability of Porter’s Generic Strategies in the Digital Age: Assumptions, Conjectures, and Suggestions Eonsoo Kim Department of Management, Korea University, 5-1 Anam-dong Sungbuk-ku, Seoul, 136-701, South Korea

Dae-il Nam LG Economic Research Institute, LG Twin Towers, East Tower 33rd Floor, 20, Yoido-dong Youngdungpo-gu, Seoul, 150-721, South Korea

J.L. Stimpert∗ Department of Economics and Business, Colorado College, 14 East Cache La Poudre Street, Colorado Springs, CO 80903, USA Received 16 October 2002; received in revised form 10 July 2003; accepted 16 December 2003 Available online 15 June 2004

Because current management theories evolved in the context of brick-and-mortar firms, this paper examines three key questions raised by the advent of e-business: (1) Will the strategy types found among e-business firms resemble Porter’s (1980) generic strategies? (2) Will we find performance differences among e-business firms pursuing different types of strategies? (3) Will we find differences in the strategy-performance relationships of pure online firms (pure plays) and firms with both online and offline operations (clicks-and-bricks)? We conclude that integrated strategies that combine elements of cost leadership and differentiation will outperform cost leadership or differentiation strategies. We also argue that, regardless of business strategy type, clicks-and-bricks firms that closely integrate their on- and offline operations will enjoy performance advantages over their pure play counterparts. © 2004 Elsevier Inc. All rights reserved.

Enthusiasm for e-business has waned since the Internet boom of the late 1990s, but business 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.: +1 719 389 6418; fax: +1 719 389 6927. E-mail addresses: [email protected] (E. Kim), [email protected] (D.-i. Nam), [email protected] (J.L. Stimpert).

0149-2063/$ – see front matter © 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.jm.2003.12.001

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companies slash costs. It is speeding the pace of innovation and jacking up productivity . . . Of the publicly held Internet companies that survived the shakeout, some 40 percent were profitable in the fourth quarter of 2002” (Business Week, 2003b:44). Expedia.com is now the top leisure-travel agency online or off, while 13 percent of all traditional travel agency locations closed in 2002. Expedia also has higher profit margins than American Express. Nearly every public Internet-based financial services company is profitable. And, while less than five percent of all shopping is done online, eBay will become one of the top 15 retailers in the United States during 2003, and Amazon.com will move into the top 40 (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 Internet 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 last 100 years. Managers and scholars alike are struggling to understand how economic and business rules have changed and should change. Many have claimed that existing business 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 advantage in offline markets? and (2) Are strategy perspectives and tools that were formulated in a competitive landscape inhabited by offline firms still relevant in the new world of e-business? This paper addresses these important issues by examining how existing strategy frameworks, models, and tools are, and are not, applicable in this new Internet age. We explore: (a) when the strategy types found among e-business firms resemble Porter’s (1980) generic strategies, (b) when we will find performance difference among e-business firms pursuing different strategy types, and (c) when we will find differences in the strategy-performance relationships of pure online firms (pure plays) and firms with both on- and offline operations (clicks-and-bricks). Although current management theories evolved in the context of brick-and-mortar firms, we propose that Porter’s generic strategy framework is still applicable, albeit in need of some modification, to competition in the digital age.

Background Porter’s Typology A major stream of strategy research examines the relationship between strategy type and firm performance (Carter, Stearns, Reynolds, & Miller, 1994; Dess & Davis, 1984; Fahey &

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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 to firm performance. Second, Porter’s framework overlaps with other typologies. For example, Porter’s strategy of differentiation 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 that firms 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, some firms do not pursue a viable business strategy, and he labels these firms “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, a firm 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 that firms can become stuck in the middle by trying to pursue more than one generic strategy simultaneously. Characteristics of the E-Business Environment While Porter’s typology has received a good deal of empirical support in traditional business 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-business firms (Smith, Bailey, & Brynjolfsson, 1999). An extensive body of literature 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 allows firms 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). Since

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information flows 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 allows firms 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 provides firms with more detailed and higher quality information on customer transactions. Information 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-business firms potentially very important advantages in being able to target their product or service offerings to specific customers. For example, Amazon.com uses collaborative filtering 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 service firms. A study by Andersen Consulting (as cited in Yelkur & DaCosta, 2001) provides examples of improved transaction efficiency for service industries such as travel and financial services. For example, the average cost of a banking transaction at a local branch is $1.07. Use 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 many firms 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 dot.com 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). Amazon.com 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 also flooded 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, Internet firms do not necessarily offer lower prices than traditional firms. 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 of

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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 information 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 catalog 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 – promotion, 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 activities. 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 important 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 Strategies Assumptions and Necessary Conditions for E-Business Competitive Strategy We 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 that firms 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-

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venience, and quality. Companies offering products or services online must demonstrate that they provide real benefits (Porter, 2001). The demise of Priceline.com’s reverse auction 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 online firms differentiate themselves from other firms. 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 to firms that employ successful differentiation strategies (Clay et al., 2002). In the following sections, we explore these strategic options and consider possible variations. Cost Leadership Strategy Cost leadership can be an obvious strategic choice for many e-business firms. Although lower costs do not necessarily mean lower prices, lower prices have been a key selling point for e-business firms like Expedia.com, 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, 71 percent of 500 first-time online shoppers indicated that price was their most important consideration (Kim & Kim, 2000). The Internet also allows firms to adjust their prices quickly so they can enjoy greater pricing flexibility and more efficient price competition (Bakos, 1998; Lee & Gosain, 2002). The Internet also helps consumers overcome bounded rationality in terms of price scanning. 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 comparison 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 a firm to enjoy increasing returns, it must secure a critical mass of consumers as soon as possible. Competitive pricing is often the quickest and easiest way for a firm 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 online firms to differentiate themselves, since they lack many potential points of

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distinction 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 dot.com 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 Strategy As noted above, differentiation can be based on many elements or factors, including design, brand image, reputation, technology, product features, networks, and customer service. Any successful differentiation strategy must be based on elements that are difficult for competitors to imitate. In spite of conditions that encourage e-business firms 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 to firms 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 provided 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 design 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-business firms to differentiate themselves have confirmed the importance of branding and other non-price factors. For example, a study of 13 online 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 Amazon.com’s unit prices were five percent higher than Barnesandnoble.com’s prices and 11 percent higher than Borders.com’s prices, providing some indirect evidence of product differentiation. The two leading online retailers of CDs in the US that together account for more than 80 percent of the total market share are not the dominant price leaders (Lee & Gosain, 2002). These findings suggest that customers may be “price rational” but not

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necessarily “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 Amazon.com 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 to find 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 other firms. 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 Strategy Firms pursuing a focus strategy target specific groups of buyers, product lines, or geographic 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, established firms 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 of fixed 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 allows firms 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 a firm to communicate 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 location) are not present. When products and services are capable of significant differentiation, however, the Internet can help segment consumers and direct them toward the appropriate 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).

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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 should find that Internet technologies make Porter’s (1980) competitive scope dimension infinitely scalable. As noted earlier, scalability and market scope flexibility – 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-business firms.

Generic Strategies and E-Business Performance Cost leadership is widely practiced today among e-business firms that sell standardized products and services such as books (Barnesandnoble.com) and travel (Expedia.com). Indeed, among first-time online shoppers, price may well be the most important factor influencing 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 that firms 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 proprietary offerings, thus intensifying the rivalry among competitors. Internet technologies tend to reduce variable costs, tilting cost structures toward fixed cost and creating significantly 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 other firms, so that purchased inputs become more homogeneous, 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-business firms. 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 many fledgling 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 customized online experience, convenience, or some combination of all of these factors, is likely to be a more viable strategy. Firms like Amazon.com 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.

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Traditionally, cost leadership and differentiation or their equivalents were regarded as equally effective strategies (Porter, 1980). We suggest otherwise. For obvious reasons, price competition will almost certainly intensify in the Internet business environment, and firms with commodity-like products and services will face great pressure to keep their prices as low as possible. Therefore, the preferred strategy choice for firms wanting to survive on the Internet would be differentiation. Hence, we offer the following proposition: Proposition 1: In e-business, the generic strategy of differentiation will be associated with higher performance than the generic strategy of cost leadership. As discussed earlier, Internet technologies potentially give all online retailers the ability to target both broad and narrow customer segments. Firms that pursue narrowly focused strategies are unlikely to be as successful as firms pursuing either cost leadership or differentiation strategies because those firms can take advantage of the infinite scalability of Internet technologies to reach simultaneously both broad and narrow customer segments. So, unlike Porter (1980), who argued that firms could viably serve very narrow market segments, we propose that firms pursuing strategies of focus cost leadership or focus differentiation will be less viable than firms that take advantage of the scalability of Internet technologies: Proposition 2: In e-business, the generic strategy of focus will be less viable than the generic strategies of cost leadership or differentiation.

“Stuck in the Middle” Versus “Integrated” Strategies and E-Business Performance Porter (1980) argued that cost leadership and differentiation are such fundamentally contradictory strategies, requiring such different sets of resources, that any firm attempting to combine them would wind up “stuck in the middle” and fail to enjoy superior performance. From a traditional business perspective, cost leadership and differentiation do seem incompatible. Cost leadership requires standardized products with few unique or distinctive features or services so that costs are kept to a minimum. On the other hand, differentiation usually depends on offering customers unique benefits and features, which almost always increase production and marketing costs (Hitt, Ireland, & Hoskisson, 2001). Subsequent studies have both supported and called into question Porter’s claims. Studies by Dess and Davis (1984) and Kim and Lim (1988) found that firms employing only one of Porter’s generic strategies outperformed firms pursuing elements of more than one strategy. Robinson and Pearce (1988), in their study of 97 manufacturing firms, found that stuck in the middle firms showed lower levels of performance. Several other studies have, however, challenged Porter’s typology and questioned his claims about the exclusivity of the generic strategies (Booth & Philip, 1998; Glazer, 1991; Karnani, 1984; Wright, Knoll, Caddie, & Pringle, 1990). For example, Hill (1988) argued that sustainable competitive advantage rests on the successful combination of these two strategies. Murray (1988) criticized Porter’s typology, and noted that the development of any successful business strategy must reflect the larger competitive environment. He argues that since industry environments do not specifically prescribe the need for cost leadership or differentiation, there is little

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reason to conclude that only one strategy should be employed in response to any particular environment. Furthermore, turbulent global environments require firms to adopt flexible combinations of strategies (Chan & Wong, 1999; Kim & McIntosh, 1999). Any incompatibility between cost leadership and differentiation may hold true in more stable environments, but rapidly changing competitive environments call for more flexibility and the ability to combine elements of more than one generic strategy. Mass customization and the development of network organizations both demand and make possible the flexible combination of multiple strategies (Anderson, 1997; Pine, 1993; Preiss, Goldman, & Nagel, 1996). Evans and Wurster (1999) concluded that the Internet disassembles traditional value chains, introducing new competitive imperatives and requiring new strategies. One doesn’t have to agree completely with these sweeping observations to accept that the Internet has reduced trade-offs between information richness and information reach, or that the Internet’s universality and its ability to reduce information asymmetries and transactions costs have created opportunities to “rewrite the rules” of business strategy (Afuha & Tucci, 2001). Merrilees (2001) observed that several online companies have successfully employed a combination of cost leadership and differentiation, and Amazon.com is offered as a case in point. Amazon.com’s skills at branding, innovation, and channel management have successfully differentiated it from its competitors, but the company routinely offers low list prices on much of its merchandise. As a result, it is difficult to classify Amazon.com into either strategy type. Amazon.com does emphasize low prices and offers many discounts, but it has also been very innovative. Amazon.com’s Web site was designed around a straightforward five-step process that makes the consumer shopping experience convenient and helpful. Prompt delivery is also a hallmark of the Amazon.com shopping experience. While we do not want to minimize the very real challenges of pursuing a successful combination of generic strategies (Hitt et al., 2001; Porter, 1980), we believe that an integrated strategy combining elements of cost leadership and differentiation is not only possible but is the most successful strategy for e-business firms to pursue. As discussed in the previous section, the strategy of cost leadership suffers from many inherent disadvantages. It is thus likely to offer lower performance than an integrated strategy that combines the best features of cost leadership and differentiation. We also expect that an integrated strategy will have higher performance than a pure differentiation strategy, since a strategy of pure differentiation does not take advantage of the Internet’s potential for lowering costs. Thus, we offer the following proposition: Proposition 3: Integrated strategies combining elements of cost leadership and differentiation will result in higher performance than cost leadership or differentiation do individually.

Pure Plays, Clicks-and-Bricks, and Firm Performance Two broad types of Internet businesses exist: pure online firm (pure plays) and firms with both online and offline businesses (clicks-and-bricks). During the earlier stages of e-business, many observers believed pure plays would be in a stronger competitive position.

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It was thought that pure plays would be more flexible and better able to leverage their first mover advantages, and that they would not be hindered by conflicts between online and traditional marketing channels. They would also enjoy greater flexibility in pricing. Netscape provides a good example of a pure online firm that was able to seize a dominant share of the browser market by ignoring conventional rules (Yoffie & Cusumano, 1999). Dell is another company that gained significant advantages by pursuing an online strategy. In fact, traditional offline firms, which joined the Internet as second movers, did struggle at first. By the end of 1998, however, many of these firms were becoming market leaders. A recent market survey found that clicks-and-bricks firms such as Barnes & Noble, Toys ‘R’ Us, and KBKids are among the largest Internet shopping sites (Bulik, 2000). Advantages of Clicks-and-Bricks Firms Since clicks-and-bricks firms are already familiar to customers and have credible brands, other things being equal, customers should prefer clicks-and-bricks Internet sites. Brynjolfsson and Smith (2000) concluded that the brand recognition, reputation, and credibility of clicks-and-bricks firms are important advantages that pure plays often lack. Furthermore, clicks-and-bricks firms can offer product returns and other customer services through their physical storefronts (Griffith, 1999). Zettlemeyer (1996) showed that clicks-and-bricks firms could enjoy higher performance by properly combining their online and offline businesses, whereas the ability of pure plays to provide information would be limited to their online channel. In fact, recently many pure plays are realizing the advantages of adding offline elements such as warehousing (Glover, Liddle, & Prawitt, 2001). Modahl (2000) concluded that e-business would be dominated by clicks-and-bricks, particularly by established firms that expand online by leveraging their offline assets such as distribution channels, brand reputation, and credibility. Support for this perspective comes from an empirical study by Uhlenbruck, Hitt, and Semadeni (2001), which found that “old economy firms” could achieve positive market returns by acquiring Internet firms. Office Depot has employed the Web to improve its catalog services. Without printing more catalogs, the company’s customers can access updated and accurate information through the Web and complete transactions online. Walgreen’s, which has established an online site for ordering prescriptions, has found that its extensive network of stores remains a potent advantage, even as much prescription ordering shifts to the Internet. Fully 90 percent of the company’s customers who place orders over the Web prefer to pick up their prescriptions at a nearby Walgreen’s store rather than have them shipped to their homes, most likely to save shipping costs. The Gap’s online customers will find an almost seamless integration between the company’s Web site and the product offerings at its physical stores (Head et al., 2000). Tight integration between a company’s Web site and its physical store locations not only increases customer value, but it can also reduce costs. It is more efficient to take and process orders via the Web, but it is also more efficient to make bulk deliveries to a local stocking location than to ship individual customer orders from a central warehouse (Porter, 2001). A recent article in The Wall Street Journal noted that many clicks-and-bricks firms are encouraging customers to pick up merchandise ordered online at their physical store locations. Not only does customer pick up save what are often substantial shipping charges

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(especially on large or heavy items), but companies also find that customer pick up leads to more impulse purchases. The article cited an executive at REI who estimated that “online shoppers who pick up their items in stores spend an additional $90 before they walk out the door” (Xiong, 2003, D4). It would seem that an obvious advantage for pure plays is the potential for lower costs due to the absence of physical store locations or warehousing facilities, but Schlauch and Laposa (2001) found that pure play firms were not realizing significant real estate-related cost savings over their clicks-and-bricks competitors, perhaps because they must frequently incur substantial costs to develop elaborate supply chain networks. Furthermore, many customers have used the Internet as a source of product and service information, but still prefer to make their purchases through traditional channels (Yang & Jun, 2002). If this customer segment remains large, then clicks-and-bricks firms will enjoy further advantages over pure plays. Pure plays face a number of other drawbacks. First, their customers cannot physically examine, touch, and test products, and they often get little or no help in using or repairing them. In addition, knowledge transfer is restricted to codified knowledge, sacrificing the spontaneity and judgment that can result from interactions with skilled sales personnel. It’s always possible that advances in Internet technology will allow pure plays to offer highly personalized customer service – Amazon.com with its personalized customer recommendations offers an example of what is currently possible – but the lack of human contact with customers eliminates a powerful tool for responding to questions, providing advice, and motivating purchases. Finally, the lack of a physical storefront, fixtures, and amenities limits the ability of pure play firms to reinforce a brand image (Porter, 2001). Potential Problems Faced by Clicks-and-Bricks Clicks-and-bricks firms also face a number of drawbacks. First, unless on- and offline operations are tightly integrated, a firm will see few synergies from having both an online and a physical presence. For example, Barnes & Noble’s decision to spin-off Barnesandnoble.com as a separate organization is now viewed as a mistake. It prevented the online store from capitalizing on the many advantages provided by Barnes & Noble’s network of physical stores (Porter, 2001). Similarly, visitors to the Web site of Angus and Robertson, an upscale Australian book retailer, are likely to be confused by the low prices emphasized by the company’s online store, since this theme is inconsistent with the upmarket positioning of the company’s physical stores (Merrilees, 2001). Old economy companies – those that were not created to employ an Internet business model but instead have added Web activities to their traditional operations – face considerable hurdles in establishing online operations. Not surprisingly, Scott and Walter (2003) found that the most serious problem facing these old economy companies is strategy related, specifically, the need to effectively align their e-business and traditional strategies. All in all, at this stage of evolution, it appears that clicks-and-bricks firms can enjoy a number of advantages over pure plays, but to realize these advantages, they must effectively integrate their online and physical operations. Pure plays face all of the difficulties of establishing online operations (e.g., intense rivalry, pressure to lower prices, and the difficulty of establishing brand name recognition), without any of the opportunities to leverage

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their online operations with offline assets that clicks-and-bricks firms enjoy. Based on these arguments, we offer a final proposition: Proposition 4: In e-business, the relationship between strategy and performance will be mediated by type of firm, with clicks-and-bricks firms that tightly integrate their on- and offline operations enjoying performance advantages over pure play firms.

Conclusion We raised three research questions at the outset of this paper: (1) Will the strategy types found among e-business firms resemble Porter’s (1980) generic strategies? (2) Will we find performance differences among e-business firms pursing different types of strategies? (3) Will we find differences in the strategy-performance relationships of pure plays and clicks-and-bricks firms? Addressing the first question, we argued that Porter’s generic strategies of differentiation and cost leadership will still be applicable to e-business firms in a broad sense. We also argued that, although cost leadership and differentiation strategies will be employed and observed among e-business firms, a strategy of focus will not be as viable as it has been in traditional business contexts. Regarding the second question, we propose that differentiation will show superior performance to cost leadership in e-business contexts. We also proposed that a third type of strategy will be observed and that it will outperform both cost leadership and differentiation. We used the term “integrated strategy” to indicate that this strategy successfully combines cost leadership and differentiation (Hitt et al., 2001). It is distinguished from Porter’s stuck in the middle conundrum in that (1) while stuck in the middle suggests no clear strategic focus, an integrated strategy is a desirable strategic position in the e-business environment, and therefore, (2) it should be treated as one of the three prototypes of strategy along with cost leadership and differentiation. As a result, we suggest that the concept of generic strategy be modified as shown in Figure 1. Figure 1 is the traditional two-by-two Porter (1980) classification. Figure 1a shows the same classification, without the “competitive scope” dimension. We argued that, given the scalability of Internet technologies, e-business firms should necessarily be pursuing simultaneously broad and narrow customer segments, thus rendering a strategy of focus less viable as a distinct strategic option. Furthermore, due to the characteristics of the Internet, we argued that the integrated strategy is not only a feasible but also a desirable strategic option. Therefore, as presented in Figure 1b, we argue that the previously dichotomous view of cost leadership and differentiation as incompatible strategies should be modified into two extreme cases on a continuum with the integrated strategy bridging the two. Regarding the third and last question, we proposed that clicks-and-bricks firms will outperform pure plays with a condition: Recognizing the characteristics of clicks-and-bricks firms and assessing both their advantages as well as their disadvantages, we suggest that clicks-and-bricks firms will enjoy superior performance relative to their pure play counterparts only when their online and offline operations are aligned and tightly integrated.

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Competitive Advantage

Narrow Broad

Competitive Scope

Low Cost

Cost Leadership

Uniqueness

Cost Leadership

Differentiation

Focus

Stuck in the middle

Differentiation

(a)

Competitive Advantage Low Cost

Combination of Both

Cost Leadership

Integrated Strategy

Uniqueness

Differentiation

(b) Figure 1. Traditional classification of competitive strategies. (a) E-business classification of competitive strategies with focus embedded. (b) E-business competitive strategy as a continuum.

Managerial Implications When e-business was in its infancy, many firms were obsessed with the need to develop an Internet presence. Without a well thought-out strategy for pursuing e-business opportunities, many firms failed to develop distinctive strategies and failed to differentiate their online operations (Merrilees, 2001). All too often, firms have pursued destructive, cost-based competition rather than differentiation (Magretta, 2002). In short, many firms were attracted

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to what we earlier described as the “myth of lower cost and price,” even though the Internet makes a strategy of cost leadership especially difficult to sustain. We believe that many firms have pursued cost leadership not because it is more rational or advantageous, but as a default for insightful strategic thinking. Porter (2001) reminds us that pursuing a distinctive strategic position – i.e., differentiation – has been always more difficult and requires a good deal more creativity than pursuing operational efficiency or a strategy of cost leadership. Merrilees (2001) emphasized that the strategy of cost leadership requires a fairly straightforward set of integrating tasks – vividly displaying low prices and running all company operations on a no-frills basis. The openness of the Internet, combined with advances in software architecture, Web development tools, and modularity, makes it much easier for companies to design and implement new applications. It is therefore more difficult to sustain purely operational advantages in the Internet environment (Porter, 2001). By contrast, differentiation requires a complex integration of strategy, tactics, and capabilities. The reward in the latter case, however, is that a unique set of competencies is created to help sustain a competitive advantage over a longer period of time. Differentiation is harder to achieve but, once achieved, it offers greater likelihood of sustained high performance. This paper also proposes that a cost leadership strategy will not produce superior performance for e-business firms. Since the Internet can help all players drive down costs (and prices), a differentiated strategic position will prove to be a more viable way to develop and maintain distinctiveness, offer superior customer value, and charge higher prices. Instead of emphasizing price competition, firms should take advantage of the Internet’s ability to support convenience, speed, interactive service, and customization. Trust, credibility, and brand name recognition – which are at the heart of differentiation – become even more important in the e-business world where there is often little or no physical contact between customers and company personnel. Firms have many ways to differentiate themselves: through marketing and advertising, Web site design, customer reviews, newsletters, gift services, loyalty programs, convenience, and customized recommendations, to name just a few (Clay et al., 2002). Differentiation is possible even for seemingly undifferentiated products and services. Amazon.com has demonstrated that, although books are homogeneous goods, the book buying experience doesn’t have to be. At the same time, it would, of course, be foolish not to employ the Internet’s cost-cutting features. Thus, we suggest that e-business firms should move away from a pure cost leadership strategy toward differentiation or toward integrated strategies that combine the best features of cost leadership and differentiation. We also propose that clicks-and-bricks firms that achieve a tight integration between their on- and offline operations should enjoy performance advantages over their pure play counterparts. This conclusion also offers some implications for practice. First, for clicks-and-bricks firms, it emphasizes the importance of coordinating on- and offline activities. For pure plays, it suggests that performance might be enhanced by partnering or joining with vendors and other firms to develop products, services, or retail interfaces that improve the overall customer shopping experience. As we have noted throughout the paper (and address specifically in the next section), many pure play firms have already moved in this direction and begun to function much more like traditional, offline retailers. Further, there are almost certainly opportunities for pure plays to realize value by merging with, acquiring, or being acquired by brick-and-mortar firms (Uhlenbruck et al., 2001).

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Directions for Future Research As researchers begin to empirically test this paper’s propositions, they will need to resolve several theoretical and methodological issues. The first issue is the classification of pure play and clicks-and-bricks firms. We believe that simply classifying e-business firms into pure play and clicks-and-bricks categories could be misleading. Many pure play retailers have relied on alliances with other firms to provide warehousing and distribution services, while other pure play firms have begun to function more like traditional retailers, purchasing goods from manufacturers and distributors and warehousing these products before they are shipped to customers. Amazon.com with its growing network of warehouses and distribution centers is an example (Schlauch & Laposa, 2001). In many ways, this issue is a question of vertical integration or how much of the value chain an e-business chooses to own. Some pure plays have chosen to own more of the value chain and have, for example, in-house physical distribution and order-fulfillment capabilities. These firms may be able to offer faster or higher quality service to their customers, and they may also be able to blunt some of the advantages clicks-and-bricks firms enjoy by having both online and offline operations. We suggest, therefore, that pure play firms should be further divided into “pure plays” and “vertically integrated online firms.” Possible synergies and potential conflicts between online and offline operations should be important considerations as incumbent firms develop their Internet strategies. We also believe that potential performance differences across pure play firms, vertically integrated online firms, and clicks-and-bricks firms should be significant enough to warrant research attention. The second issue is the choice of performance measures. One obstacle to empirical study of e-business firms is the lack of widely accepted performance measures. Many e-business-specific measures such as traffic and number of hits have been dismissed as unreliable indicators of long-term success. Porter (2001) has argued that dot.com success should be evaluated using traditional performance indicators such as profitability. Garbi (2002) countered, however, that if profitability is the sole criterion for firm performance, then many existing, but unprofitable, Internet companies should have died away by now. Garbi (2002) compared surviving and failing dot.coms along various performance measures, including asset productivity, shareholder value, growth and survival, and an ecommerce-specific performance indicator (the number of unique visitors). Dot.com survivors had significantly higher levels of asset productivity and unique visitors. Garbi also found that the e-business-specific performance measure – number of unique visitors – is significantly correlated with measures of market value and growth. This implies that cyberspace-specific performance indicators, such as page views, stickiness, click-through rate, and conversion rate, may be reliable performance measures in studies of e-business firms. We recommend that researchers adopt an eclectic, multidimensional approach to assessing the performance of e-business firms, relying on a combination of traditional performance yardsticks, measures that are routinely used to gauge the success of other types of start-up businesses, and a variety of e-business-specific measures. Regardless of how these methodological issues are resolved, we believe the implications of the new business landscape are profound enough to warrant considerable scholarly interest, theory development, and empirical research. We hope that this paper helps to lay

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a theoretical foundation for studying firms in the information age and that it serves as a catalyst to stimulate future investigation as well.

Acknowledgments Research support was provided by the Institute for Business Research and Education at Korea University and by the Department of Economics and Business at Colorado College. The authors appreciate the many helpful comments and suggestions provided by the reviewers and the editor. We also acknowledge the assistance provided by Robin Satterwhite and Marla Gerein.

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Eonsoo Kim is Professor of Management at Korea University. Professor Kim received his Ph.D. from the University of Illinois, and his research interests include strategic change, process, and implementation. He has written on corporate and business strategy issues, including strategic responses to environmental change, downsizing and turnaround, network and project-based organizations, and the application of the military art of war to strategic management. Dae-il Nam is Senior Consultant at the LG Economic Research Institute. Mr. Nam received his Master’s degree from Korea University. His research and consulting focus on strategy formulation and implementation, including industry consolidation, convergence marketing,

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global market strategy, corporate venture incubation, corporate governance, leadership appraisal, and vision. Larry Stimpert is Professor of Economics and Business at Colorado College. Professor Stimpert received his Ph.D. from the University of Illinois, and his research interests include top managers and their influence on strategic decision making and organizational strategies. He has written on many strategy issues, including managerial responses to environmental change and organizational decline, business definition and organizational identity, the management of corporate strategy and diversification, corporate governance, and company strategies following deregulation.