Why Study Netflix?

Studying Netflix gives us a chance to examine how technology helps firms craft and reinforce a competitive advantage. We’ll pick apart the components of the firm’s strategy and learn how technology played a starring role in placing the firm atop its industry. We also realize that while Netflix emerged the victorious underdog at the end of the first show, there will be at least one sequel, with the final scene yet to be determined. We’ll finish the case with a look at the very significant challenges the firm faces as new technology continues to shift the competitive landscape.

Selection: The Long Tail in Action

Customers have flocked to Netflix in part because of the firm’s staggering selection. A traditional video store (and Blockbuster had some 7,800 of them) stocks roughly three thousand DVD titles on its shelves. For comparison, Netflix is able to offer its customers a selection of over one hundred thousand DVD titles, and rising! At traditional brick-and-mortar retailers, shelf space is the biggest constraint limiting a firm’s ability to offer customers what they want when they want it. Just which films, documentaries, concerts, cartoons, TV shows, and other fare make it inside the four walls of a Blockbuster store is dictated by what the average consumer is most likely to be interested in. To put it simply, Blockbuster stocks blockbusters.

Finding the right product mix and store size can be tricky. Offer too many titles in a bigger storefront and there may not be enough paying customers to justify stocking less popular titles (remember, it’s not just the cost of the DVD—firms also pay for the real estate of a larger store, the workers, the energy to power the facility, etc.). You get the picture—there’s a breakeven point that is arrived at by considering the geographic constraint of the number of customers that can reach a location, factored in with store size, store inventory, the payback from that inventory, and the cost to own and operate the store. Anyone who has visited a video store only to find a title out of stock has run up against the limits of the physical store model.

But many online businesses are able to run around these limits of geography and shelf space. Internet firms that ship products can get away with having just a few highly automated warehouses, each stocking just about all the products in a particular category. And for firms that distribute products digitally (think songs on iTunes), the efficiencies are even greater because there’s no warehouse or physical product at all (more on that later).

Offer a nearly limitless selection and something interesting happens: there’s actually more money to be made selling the obscure stuff than the hits. Music service Rhapsody makes more from songs outside of the top ten thousand than it does from songs ranked above ten thousand. At Amazon.com, roughly 60 percent of books sold are titles that aren’t available in even the biggest Borders or Barnes & Noble Superstores.C. Anderson, “The Long Tail,” Wired 12, no. 10 (October 2004), http://www.wired.com/wired/archive/12.10/tail.html. And at Netflix, roughly 75 percent of DVD titles shipped are from back-catalog titles, not new releases (at Blockbuster outlets the equation is nearly flipped, with some 70 percent of business coming from new releases).B. McCarthy, “Netflix, Inc.” (remarks, J. P. Morgan Global Technology, Media, and Telecom Conference, Boston, May 18, 2009). Consider that Netflix sends out forty-five thousand different titles each day. That’s fifteen times the selection available at your average video store! Each quarter, roughly 95 percent of titles are viewed—that means that every few weeks Netflix is able to find a customer for nearly every DVD title that has ever been commercially released.

This phenomenon whereby firms can make money by selling a near-limitless selection of less-popular products is known as the long tailIn this context, refers to an extremely large selection of content or products. The long tail is a phenomenon whereby firms can make money by offering a near-limitless selection.. The term was coined by Chris Anderson, an editor at Wired magazine, who also wrote a best-selling business book by the same name. The “tail” (see Figure 4.2 “The Long Tail”) refers to the demand for less popular items that aren’t offered by traditional brick-and-mortar shops. While most stores make money from the area under the curve from the vertical axis to the dotted line, long tail firms can also sell the less popular stuff. Each item under the right part of the curve may experience less demand than the most popular products, but someone somewhere likely wants it. And as demonstrated from the examples above, the total demand for the obscure stuff is often much larger than what can be profitably sold through traditional stores alone. While some debate the size of the tail (e.g., whether obscure titles collectively are more profitable for most firms), two facts are critical to keep above this debate: (1) selection attracts customers, and (2) the Internet allows large-selection inventory efficiencies that offline firms can’t match.

The long tail works because the cost of production and distribution drop to a point where it becomes economically viable to offer a huge selection. For Netflix, the cost to stock and ship an obscure foreign film is the same as sending out the latest Will Smith blockbuster. The long tail gives the firm a selection advantage (or one based on scale) that traditional stores simply cannot match.

For more evidence that there is demand for the obscure stuff, consider Bollywood cinema—a term referring to films produced in India. When ranked by the number of movies produced each year, Bollywood is actually bigger than Hollywood, but in terms of U.S. demand, even the top-grossing Hindi film might open in only one or two American theaters, and few video stores carry many Bollywood DVDs. Again, we see the limits that geography and shelf space impose on traditional stores. As Anderson puts it, when it comes to traditional methods of distribution, “an audience too thinly spread is the same as no audience at all.”C. Anderson, “The Long Tail,” Wired 12, no. 10 (October 2004), http://www.wired.com/wired/archive/12.10/tail.html. While there are roughly 1.7 million South Asians living in the United States, Bollywood fans are geographically disbursed, making it difficult to offer content at a physical storefront. Fans of foreign films would often find the biggest selection at an ethnic grocery store, but even then, that wouldn’t be much. Enter Netflix. The firm has found the U.S. fans of South Asian cinema, sending out roughly one hundred thousand Bollywood DVDs a month. As geographic constraints go away, untapped markets open up!

The power of Netflix can revive even well-regarded work by some of Hollywood’s biggest names. In between The Godfather and The Godfather Part II, director Francis Ford Coppola made The Conversation, a film starring Gene Hackman that, in 1975, was nominated for a Best Picture Academy Award. Coppola has called The Conversation the finest film he has ever made,D. Leonhardt, “What Netflix Could Teach Hollywood,” New York Times, June 7, 2006. but it was headed for obscurity as the ever-growing pipeline of new releases pushed the film off of video store shelves. Netflix was happy to pick up The Conversation and put it in the long tail. Since then, the number of customers viewing the film has tripled, and on Netflix, this once underappreciated gem became the thirteenth most watched film from its time period.

For evidence on Netflix’s power to make lucrative markets from nonblockbusters, visit the firm’s “Top 100 page.”http://www.netflix.com/Top100. You’ll see a list loaded with films that were notable for their lack of box office success. As of this writing the number one rank had been held for over five years in a row, not by a first-run mega-hit, but by the independent film Crash (an Oscar winner, but box office weakling).R. Elder, “‘Crash’ Remains Top DVD Rental,” Chicago Tribune, April 14, 2009.

Netflix has used the long tail to its advantage, crafting a business model that creates close ties with film studios. In most cases, studios earn a percentage of the subscription revenue for every disk sent out to a Netflix customer. In exchange, Netflix gets DVDs at a very low cost. The movie business is characterized by large fixed costs up front. Studio marketing budgets are concentrated on films when they first appear in theaters, and when they’re first offered on DVD. After that, studios are done promoting a film, focusing instead on their most current titles. But Netflix is able to find an audience for a film without the studios spending a dime on additional marketing. Since so many of the titles viewed on Netflix are in the long tail, revenue sharing is all gravy for the studios—additional income they would otherwise be unlikely to get. It’s a win-win for both ends of the supply chain. These supplier partnerships grant Netflix a sort of soft bargaining power that’s distinctly opposite the strong-arm price bullying that giants like Wal-Mart are often accused of.

Cinematch: Technology Creates a Data Asset That Delivers Profits

Netflix proves there’s both demand and money to be made from the vast back catalog of film and TV show content. But for the model to work best, the firm needed to address the biggest inefficiency in the movie industry—“audience finding,” that is, matching content with customers. To do this, Netflix leverages some of the industry’s most sophisticated technology, a proprietary recommendation system that the firm calls Cinematch.

Each time a customer visits Netflix after sending back a DVD, the service essentially asks “So, how did you like the movie?” With a single click, each film can be rated on a scale of one to five stars. If you’re new to Netflix, the service can prompt you with a list of movies (or you can search out and rate titles on your own). Love Rushmore but hate The Life Aquatic? Netflix wants to know.

The magic of Cinematch happens not by offering a gross average user rating—user tastes are too varied and that data’s too coarse to be of significant value. Instead, Cinematch develops a map of user ratings and steers you toward titles preferred by people with tastes that are most like yours. Techies and marketers call this trick collaborative filteringA classification of software that monitors trends among customers and uses this data to personalize an individual customer’s experience.. The term refers to a classification of software that monitors trends among customers and uses this data to personalize an individual customer’s experience. Input from collaborative filtering software can be used to customize the display of a Web page for each user so that an individual is greeted only with those items the software predicts they’ll most likely be interested in. The kind of data mining done by collaborative filtering isn’t just used by Netflix; other sites use similar systems to recommend music, books, even news stories. While other firms also employ collaborative filtering, Netflix has been at this game for years, and is constantly tweaking its efforts. The results are considered the industry gold standard.

Collaborative filtering software is powerful stuff, but is it a source of competitive advantage? Ultimately it’s just math. Difficult math, to be sure, but nothing prevents other firms from working hard in the lab, running and refining tests, and coming up with software that’s as good, or perhaps one day even better than Netflix’s offering. But what the software has created for the early-moving Netflix is an enormous data advantage that is valuable, results yielding, and impossible for rivals to match. Even if Netflix gave Cinematch to its competitors, they’d be without the over 3 billion ratings that the firm has amassed (according to the firm, users add about a million new ratings to the system each day). More ratings make the system seem smarter, and with more info to go on, Cinematch can make more accurate recommendations than rivals.

Evidence suggests that users trust and value Cinematch. Recommended titles make up over 60 percent of the content users place in their queues—an astonishing penetration rate. Compare that to how often you’ve received a great recommendation from the sullen teen behind the video store counter. While data and algorithms improve the service and further strengthen the firm’s brand, this data is also a switching cost. Drop Netflix for Blockbuster and the average user abandons the two hundred or more films they’ve rated. Even if one is willing to invest the time in recreating their ratings on Blockbuster’s site, the rival will still make less accurate recommendations because there are fewer users and less data to narrow in on similarities across customers.

One way to see how strong these switching costs are is to examine the Netflix churn rateThe rate at which customers leave a product or service.. Churn is a marketing term referring to the rate at which customers leave a product or service. A low churn is usually key to profitability because it costs more to acquire a customer than to keep one. And the longer a customer stays with the firm, the more profitable they become and the less likely they are to leave. If customers weren’t completely satisfied with the Netflix experience, many would be willing to churn out and experiment with rivals offering cheaper service. However, the year after Blockbuster and Wal-Mart launched with copycat efforts, the rate at which customers left Netflix actually fell below 4 percent, an all-time low. And the firm’s churn rates have continued to fall over time. By the middle of 2008, rates for customers in Netflix most active regions of the country were below 3 percent, meaning fewer than three in one hundred Netflix customers canceled their subscriptions each year.Netflix Investor Day presentation, May 2008, accessed via http://ir.netflix.com/events.cfm. To get an idea of how enviable the Netflix churn rates are, consider that a year earlier the mobile phone industry had a churn rate of 38.6 percent, while roughly one in four U.S. banking customers defected that year.“Industry Customer Churn Rate Increases 15%,” GeoConnexion, January 8, 2008. The article contains a summary of the Pittney Bowes G1 finding.

All of this impacts marketing costs, too. Happy customers refer friends (free marketing from a source consumers trust more than a TV commercial). Ninety-four percent of Netflix subscribers say they have recommended the service to someone else, and 71 percent of new subscribers say an existing subscriber has encouraged them to sign up. It’s no wonder subscriber acquisition costs have been steadily falling, further contributing to the firm’s overall profitability.

A Look at Operations

Tech also lies at the heart of the warehouse operations that deliver customer satisfaction and enhance brand value. As mentioned earlier, brand is built through customer experience, and a critical component of customer experience is for subscribers to get their DVDs as quickly as possible. In order to do this, Netflix has blanketed the country with a network of fifty-eight ultrahigh-tech distribution centers that collectively handle in excess of 1.8 million DVDs a day. These distribution centers are purposely located within driving distance of 119 U.S. Postal Service (USPS) processing and distribution facilities.

By 4:00 a.m. each weekday, Netflix trucks collect the day’s DVD shipments from these USPS hubs and returns the DVDs to the nearest Netflix center. DVDs are fed into custom-built sorters that handle disc volume on the way in and the way out. That same machine fires off an e-mail as soon as it detects your DVD was safely returned (now rate it via Cinematch). Most DVDs never hit the restocking shelves. Scanners pick out incoming titles that are destined for other users and place these titles into a sorted outbound pile with a new, appropriately addressed red envelope. Netflix not only helps out the postal service by picking up and dropping off the DVDs at its hubs, it presorts all outgoing mail for faster delivery. This extra effort has a payoff—Netflix gets the lowest possible postal rates for first-class mail delivery. And despite the high level of automation, 100 percent of all discs are inspected by hand so that cracked ones can be replaced, and dirty ones can be given a wipe down.B. McCarthy, “Netflix, Inc.” (remarks, J. P. Morgan Global Technology, Media, and Telecom Conference, Boston, May 18, 2009). Total in and out turnaround time for a typical Netflix DVD is just eight hours!N. Kenny, “Special Report: Inside Netflix,” WMC TV, July 7, 2009.

First-class mail takes only one day to be delivered within a fifty-mile radius, so the warehouse network allows Netflix to service over 97 percent of its customer base within a two-day window—one day is allotted for receipt; early the next morning the next item in their queue is processed; and the new title arrives at the customer’s address by that afternoon. And in 2009, the firm added Saturday processing. All this means a customer with the firm’s most popular “three disc at a time” plan could watch a movie a day and never be without a fresh title.

Warehouse processes don’t exist in a vacuum; they are linked to Cinematch to offer the firm additional operational advantages. The software recommends movies that are likely to be in stock so users aren’t frustrated by a wait.

Everyone on staff is expected to have an eye on improving the firm’s processes. Every warehouse worker gets a free DVD player and Netflix subscription so that they understand the service from the customer’s perspective and can provide suggestions for improvement. Quality management features are built into systems supporting nearly every process at the firm, allowing Netflix to monitor and record the circumstances surrounding any failures. When an error occurs, a tiger team of quality improvement personnel swoops in to figure out how to prevent any problems from recurring. Each phone call is a cost, not a revenue enhancement, and each error increases the chance that a dissatisfied customer will bolt for a rival.

By paying attention to process improvements and designing technology to smooth operations, Netflix has slashed the number of customer representatives even as subscriptions ballooned. In the early days, when the firm had one hundred and fifteen thousand customers, Netflix had one-hundred phone support reps. By the time the customer base had grown thirtyfold, errors had been reduced to the point where only forty-three reps were needed.J. McGregor, “High Tech Achiever,” Fast Company, October 2005. Even more impressive, because of the firm’s effective use of technology to drive the firm’s operations, fulfillment costs as a percentage of revenue have actually dropped even though postal rates have increased and Netflix has cut prices.

Killer Asset Recap: Understanding Scale

Netflix executives are quite frank that the technology and procedures that make up their model can be copied, but they also realize the challenges that any copycat rival faces. Says the firm’s VP of Operations Andy Rendich, “Anyone can replicate the Netflix operations if they wish. It’s not going to be easy. It’s going to take a lot of time and a lot of money.”Netflix Investor Day presentation, 2008, accessed via http://ir.netflix.com/events.cfm.

While we referred to Netflix as David to the Goliaths of Wal-Mart and Blockbuster, within the DVD-by-mail segment Netflix is now the biggest player by far, and this size gives the firm significant scale advantages. The yearly cost to run a Netflix-comparable nationwide delivery infrastructure is about $300 million.S. Reda and D. Schulz, “Concepts that Clicked,” Stores, May 2008. Think about how this relates to economies of scale. In Chapter 2 “Strategy and Technology: Concepts and Frameworks for Understanding What Separates Winners from Losers”, we said that firms enjoy scale economies when they are able to leverage the cost of an investment across increasing units of production. Even if rivals have identical infrastructures, the more profitable firm will be the one with more customers (see Figure 4.7). And the firm with better scale economies is in a position to lower prices, as well as to spend more on customer acquisition, new features, or other efforts. Smaller rivals have an uphill fight, while established firms that try to challenge Netflix with a copycat effort are in a position where they’re straddling markets, unable to gain full efficiencies from their efforts.

For Blockbuster, the arrival of Netflix plays out like a horror film where it is the victim. For several years now, the in-store rental business has been a money loser. Things got worse in 2005 when Netflix pressure forced Blockbuster to drop late fees, costing it about $400 million.T. Mullaney, “Netflix: The Mail-Order House That Clobbered Blockbuster,” BusinessWeek, May 25, 2006. The Blockbuster store network once had the advantage of scale, but eventually its many locations were seen as an inefficient and bloated liability. Between 2006 and 2007, the firm shuttered over 570 stores.A. Farrell, “Blockbuster’s CEO Ousted,” Forbes, July 2, 2007. By 2008, Blockbuster had been in the red for ten of the prior eleven years. During a three-year period that included the launch of its Total Access DVD-by-mail effort, Blockbuster lost over $4 billion.N. MacDonald, “Blockbuster Proves It’s Not Dead Yet,” Maclean’s, March 12, 2008. The firm tried to outspend Netflix on advertising, even running Super Bowl ads for Total Access in 2007, but a money loser can’t outspend its more profitable rival for long, and it has since significantly cut back on promotion. Blockbuster also couldn’t sustain subscription rates below Netflix’s, so it has given up its price advantage. In early 2008, Blockbuster even briefly pursued a merger with another struggling giant, Circuit City, a strategy that has left industry experts scratching their heads. A Viacom executive said about the firm, “Blockbuster will certainly not survive and it will not be missed.”E. Epstein, “Hollywood’s New Zombie: The Last Days of Blockbuster,” Slate, January 9, 2006, http://www.slate.com/id/2133995. This assessment has to sting, given that Viacom was once Blockbuster’s parent (the firm was spun off in 2004).

For Netflix, what delivered the triple scale advantage of the largest selection; the largest network of distribution centers; the largest customer base; and the firm’s industry-leading strength in brand and data assets? Moving first. Timing and technology don’t always yield sustainable competitive advantage, but in this case, Netflix leveraged both to craft what seems to be an extraordinarily valuable pool of assets that continue to grow and strengthen over time. To be certain, competing against a wounded giant like Blockbuster will remain difficult. The latter firm has few options and may spend itself into oblivion, harming Netflix in its collapsing gasp. And as we’ll see in the next section, while technology shifts helped Netflix attack Blockbuster’s once-dominant position, even newer technology shifts may threaten Netflix. As they like to say in the mutual fund industry “Past results aren’t a guarantee of future returns.”

Access to Content

First the content. Three years after the launch of Netflix streaming option (enabled via a “Watch Now” button next to movies that can be viewed online), only 17,000 videos were offered, just 17 percent of the firm’s long tail. And not the best 17 percent. Why so few titles? It’s not just studio reluctance or fear of piracy. There are often complicated legal issues involved in securing the digital distribution rights for all of the content that makes up a movie. Music, archival footage, and performer rights may all hold up a title from being available under “Watch Now.” The 2007 Writers Guild strike occurred largely due to negotiations over digital distribution, showing just how troublesome these issues can be.

Add to that the exclusivity contracts negotiated by key channels, in particular the so-called premium television networks. Film studios release their work in a system called windowingIndustry practice whereby content (usually a motion picture) is available to a given distribution channel for a specified time period or “window,” usually under a different revenue model (e.g., ticket sale, purchase, license fee).. Content is available to a given distribution channel (in theaters, through hospitality channels like hotels and airlines, on DVD, via pay-per-view, via pay cable, then broadcast commercial TV) for a specified time window, usually under a different revenue model (ticket sales, disc sales, license fees for broadcast). Pay television channels in particular have negotiated exclusive access to content as they strive to differentiate themselves from one another. This exclusivity means that even when a title becomes available for streaming by Netflix, it may disappear when a pay TV window opens up. If HBO or Showtime has an exclusive for a film, it’s pulled from the Netflix streaming service until the exclusive pay TV time window closes. A 2008 partnership with the Starz network helped provide access to some content locked up inside pay television windows, and deals with Disney and CBS allow for streaming of current-season shows.S. Portnoy, “Netflix News: Starz Catalog Added to Online Service, Streaming to PS3, Xbox 360 through PlayOn Beta Software,” ZDNet, October 2, 2008, http://blogs.zdnet.com/home-theater/?p=120. But the firm still has a long way to go before the streaming tail seems comparably long when compared against its disc inventory.

While studios embrace the audience-finding and revenue-sharing advantages of Netflix, they also don’t want to undercut higher-revenue early windows. Fox, Universal, and Warner have all demanded that Netflix delay sending DVDs to customers until twenty-eight days after titles go on sale. In exchange, Netflix has received guarantees that these studios will offer more content for digital streaming.

There’s also the influence of the king of DVD sales: Wal-Mart. The firm accounts for about 40 percent of DVD sales—a scale that delivers a lot of the bargaining power it has used to “encourage” studios to hold content from competing windows or to limit offering digital titles at competitive pricing during the peak new release period.R. Grover, “Wal-Mart and Apple Battle for Turf,” BusinessWeek, August 31, 2006. Apparently, Wal-Mart isn’t ready to yield ground in the shifts from atoms to bits, either. In February 2010, the retail giant spent an estimated $100 million to buy the little-known video streaming outfit VUDU.B. Stone, “Wal-Mart Adds Clout to Streaming,” New York Times, February 22, 2010. Wal-Mart’s negotiating power with studios may help it gain special treatment for VUDU. As an example, VUDU was granted exclusive high-definition streaming rights for the hit movie Avatar, offering the title online the same day the DVD appeared for sale.J. Jacobson, “VUDU/Wal-Mart Gets Avatar HD Streaming Exclusive,” Electronic House, April 22, 2010.

Studios may also be wary of the increasing power Netflix has over product distribution, and as such, they may be motivated to keep rivals around. Studios have granted Blockbuster more favorable distribution terms than Netflix. In many cases, Blockbuster can now distribute DVDs the day of release instead of waiting nearly a month, as Netflix does.J. Birchall, “Blockbuster Strikes Deal to Ensure DVD Supply,” Financial Times, April 8, 2010. Studios are likely concerned that Netflix may be getting so big that it will one day have Wal-Mart-like negotiating leverage.

Taken together, all these factors make it clear that shifting the long tail from atoms to bits will be significantly more difficult than buying DVDs and stacking them in a remote warehouse.

But How Does It Get to the TV?

The other major problem lies in getting content to the place where most consumers want to watch it: the living room TV. Netflix’s “Watch Now” button first worked only on Windows PCs. Although the service was introduced in January 2007, the months before were fueled with speculation that the firm would partner with TiVo. Just one month later, TiVo announced its partner—Amazon.com. At that point Netflix found itself up against a host of rivals that all had a path to the television: Apple had its own hardware solution in Apple TV (not to mention the iPod and iPhone for portable viewing), the cable companies delivered OnDemand through their set-top boxes, and now Amazon had TiVo.

An internal team at Netflix developed a prototype set top box that Hastings himself supported offering. But most customers aren’t enthusiastic about purchasing yet another box for their set top, the consumer electronics business is brutally competitive, and selling hardware would introduce an entirely new set of inventory, engineering, marketing, distribution, and competitive complexities.

The solution Netflix eventually settled on was to think beyond one hardware alternative and instead recruit others to provide a wealth of choice. The firm developed a software platform and makes this available to firms seeking to build Netflix access into their devices. Today, Netflix streaming is baked into televisions and DVD players from LG, Panasonic, Samsung, Sony, Toshiba, and Vizio, among others. It’s also available on all major video game consoles. A Netflix app for Apple’s iPad was available the day the device shipped. Even TiVo now streams Netflix. And that internally developed Netflix set-top box? The group was spun out to form Roku, an independent firm that launched their own $99 Netflix streamer.

The switch to Blu-ray movies may offer the most promise. Blu-ray players are on the fast track to commoditization. If consumer electronics firms incorporate Netflix access into their players as a way to attract more customers with an additional, differentiating feature, Hastings’s firm could end up with more living room access than either Amazon or Apple. There are 73 million households in the United States that have a DVD player and an Internet connection. Should a large portion of these homes end up with a Netflix-ready Blu-ray player, Hastings will have built himself an enviable base through which to grow the video streaming business.

Who’s going to win the race for delivering bits to the television is still very much an uncertain bet. The models all vary significantly. Apple’s early efforts were limited, with the firm offering only video purchases for Apple TV, but eventually moving to online “rentals” that can also play on the firm’s entire line of devices. Movie studios are now all in Apple’s camp, although the firm did temporarily lose NBC’s television content in a dispute over pricing. Amazon and Microsoft also have online rentals and purchase services, and can get their content to the television via TiVo and Xbox, respectively (yes, this makes Microsoft both a partner and a sort of competitor, a phenomenon often referred to as coopetitionWhen firms find themselves in situations where they are both competitors and collaborators, or “frenemies.” Technology is increasingly redefining products, pushing the boundaries of delivery channels, and creating situations where firms often find themselves in these collaborative/rival relationships., or frenemiesA. Brandenberger and B. Nalebuff, Co-opetition: A Revolution Mindset that Combines Competition and Cooperation: The Game Theory Strategy That’s Changing the Game of Business (New York: Broadway Business, 1997); and S. Johnson, “The Frenemy Business Relationship,” Fast Company, November 25, 2008.). Hulu, a joint venture backed by NBC, Fox, and other networks, is free, earning money from ads that run like TV commercials. While Hulu has also received glowing reviews, the venture has lagged in offering a method to get streaming content to the television. Netflix pioneered “all-you-can-eat” subscription streaming. Anyone who has at least the $8.99 subscription plan can view an unlimited number of video streams. And Blockbuster isn’t dead yet. It also streams over TiVo and has other offerings in the works.

There’s a clear upside to the model when it shifts to streaming: it will eliminate a huge chunk of costs associated with shipping and handling. Postage represents one-third of the firm’s expenses. A round-trip DVD mailing, even at the deep discounts Netflix receives from the U.S. Postal Service, runs about eighty cents. The bandwidth and handling costs to send bits to a TV set are around a nickel.B. McCarthy, “Netflix, Inc.” (remarks, J. P. Morgan Global Technology, Media, and Telecom Conference, Boston, May 18, 2009). At some point, if postage goes away, Netflix may be in a position to offer even greater profits to its studio suppliers, and to make more money itself, too.

Wrangling licensing costs presents a further challenge. Estimates peg Netflix 2009 streaming costs at about $100 million, up 250 percent in three years. But these expenses still deliver just a fraction of the long tail. Streaming licensing deals are tricky because they’re so inconsistent even when titles are available. Rates vary, with some offered via a flat rate for unlimited streams, a per-stream rate, a rate for a given number of streams, and various permutations in between. Some vendors have been asking as much as four dollars per stream for more valuable contentD. Rayburn, “Netflix Streaming Costs,” Streaming Media, June/July 2009.—a fee that would quickly erase subscriber profits, making any such titles too costly to add to the firm’s library. Remember, Netflix doesn’t charge more for streaming—it’s built into the price of its flat-rate subscriptions.

Any extra spending doesn’t come at the best time. The switch to Blu-ray movies means that Netflix will be forced into the costly proposition of carrying two sets of video inventory: standard and high-def. Direct profits may not be the driver. Rather, the service may be a feature that attracts new customers to the firm and helps prevent subscriber flight to rival video-on-demand efforts. The stealth arrival of a Netflix set-top box, in the form of upgraded Blu-ray players, might open even more customer acquisition opportunities to the firm. Bought a Blu-ray player? For just nine dollars per month you can get a ticket to the all-you-can-eat Netflix buffet. And more customers ready to watch content streamed by Netflix may prime the pump for studios to become more aggressive in licensing more of their content. Many TV networks and movie studios are leery of losing bargaining power to a dominant firm, having witnessed how Apple now dictates pricing terms to music labels. The goodwill Netflix has earned over the years may pay off if it can become the studios’ partner of first choice.

While one day the firm will lose the investment in its warehouse infrastructure, nearly all assets have a limited lifespan. That’s why corporations depreciate assets, writing their value down over time. The reality is that the shift from atoms to bits won’t flick on like a light switch; it will be a hybrid transition that takes place over several years. If the firm can grab long-tail content, grow its customer base, and lock them in with the switching costs created by Cinematch (all big “ifs”), it just might emerge as a key player in a bits-only world.

Is the hybrid strategy a dangerous straddling gambit or a clever ploy to remain dominant? Netflix really doesn’t have a choice but to try. Hastings already has a long history as one of the savviest strategic thinkers in tech. As the networks say, stay tuned!

Why Study Zara?

While competitors falter, Zara is undergoing one of the fastest global expansions the fashion world has ever seen, opening one store per day and entering new markets worldwide—seventy-three countries so far. The chain’s profitability is among the highest in the industry.D. Sull and S. Turconi, “Fast Fashion Lessons,” Business Strategy Review, Summer 2008. The fashion director for luxury goods maker LVMH calls Zara “the most innovative and devastating retailer in the world.”J. Surowiecki, “The Most Devastating Retailer in the World,” New Yorker, September 18, 2000.

Zara’s duds look like high fashion but are comparatively inexpensive (average item price is $27, although prices vary by country).C. Rohwedder, “Zara Grows as Retail Rivals Struggle,” Wall Street Journal, March 26, 2009. A Goldman analyst has described the chain as “Armani at moderate prices,” while another industry observer suggests that while fashions are more “Banana Republic,” prices are more “Old Navy.”J. Folpe, “Zara Has a Made-to-Order Plan for Success,” Fortune, September 4, 2000. Legions of fans eagerly await “Z-day,” the twice-weekly inventory delivery to each Zara location that brings in the latest clothing lines for women, men, and children.

In order to understand and appreciate just how counterintuitive and successful Zara’s strategy is, and how technology makes all of this possible, it’s important to first examine the conventional wisdom in apparel retail. To do that we’ll look at former industry leader—Gap.

Gap: An Icon in Crisis

Most fashion retailers place orders for a seasonal collection months before these lines make an appearance in stores. While overseas contract manufacturers may require hefty lead times, trying to guess what customers want months in advance is a tricky business. In retail in general and fashion in particular, there’s a saying: inventory equals death. Have too much unwanted product on hand and you’ll be forced to mark down or write off items, killing profits. For years, Gap sold most of what it carried in stores. Micky Drexler, a man with a radar-accurate sense of style and the iconic CEO who helped turn Gap’s button-down shirts and khakis into America’s business casual uniform, led the way. Drexler’s team had spot-on tastes throughout the 1990s, but when sales declined in the early part of the following decade, Drexler was left guessing on ways to revitalize the brand, and he guessed wrong—disastrously wrong. Chasing the youth market, Drexler filled Gap stores with miniskirts, low-rise jeans, and even a much-ridiculed line of purple leather pants.J. Boorstein, “Fashion Victim,” Fortune, April 13, 2006. The throngs of teenagers he sought to attract never showed up, and the shift in offerings sent Gap’s mainstay customers to retailers that easily copied the styles that Gap had made classic.

The inventory hot potato Drexler was left with crushed the firm. Gap’s same-store sales declined for twenty-nine months straight. Profits vanished. Gap founder and chairman Dan Fisher lamented, “It took us thirty years to get to $1 billion in profits and two years to get to nothing.”P. Sellers, “Gap’s New Guy Upstairs,” Fortune, April 14, 2003. The firm’s debt was downgraded to junk status. Drexler was out and for its new head the board chose Paul Pressler, a Disney executive who ran theme parks and helped rescue the firm’s once ailing retail effort.

Pressler shut down hundreds of stores, but the hemorrhaging continued largely due to bad bets on colors and styles.L. Lee, “Paul Pressler’s Fall from The Gap,” BusinessWeek, February 26, 2007. During one holiday season, Gap’s clothes were deemed so off target that the firm scrapped its advertising campaign and wrote off much of the inventory. The marketing model used by Gap to draw customers in via big-budget television promotion had collapsed. Pressler’s tenure saw same-store sales decline in eighteen of twenty-four months.J. Boorstein, “Fashion Victim,” Fortune, April 13, 2006. A Fortune article on Pressler’s leadership was titled “Fashion Victim.” BusinessWeek described his time as CEO as a “Total System Failure,”L. Lee, “Paul Pressler’s Fall from the Gap,” BusinessWeek, February 26, 2007. and Wall Street began referring to him as DMW for Dead Man Walking. In January 2007, Pressler resigned, with Gap hoping its third chief executive of the decade could right the ailing giant.

Design

Rather than create trends by pushing new lines via catwalk fashion shows, Zara designs follow evidence of customer demand. Data on what sells and what customers want to see goes directly to “The Cube” outside La Coruña, where teams of some three hundred designers crank out an astonishing thirty thousand items a year versus two to four thousand items offered up at big chains like H&M (the world’s third largest fashion retailer) and Gap.M. Pfeifer, “Fast and Furious,” Latin Trade, September 2007; and “The Future of Fast Fashion,” Economist, June 18, 2005. While H&M has offered lines by star designers like Stella McCartney and Karl Lagerfeld, as well as celebrity collaborations with Madonna and Kylie Minogue, the Zara design staff consists mostly of young, hungry Project Runway types fresh from design school. There are no prima donnas in “The Cube.” Team members must be humble enough to accept feedback from colleagues and share credit for winning ideas. Individual bonuses are tied to the success of the team, and teams are regularly rotated to cross-pollinate experience and encourage innovation.

Manufacturing and Logistics

In the fickle world of fashion, even seemingly well-targeted designs could go out of favor in the months it takes to get plans to contract manufacturers, tool up production, then ship items to warehouses and eventually to retail locations. But getting locally targeted designs quickly onto store shelves is where Zara really excels. In one telling example, when Madonna played a set of concerts in Spain, teenage girls arrived to the final show sporting a Zara knockoff of the outfit she wore during her first performance.“The Future of Fast Fashion,” Economist, June 18, 2005. The average time for a Zara concept to go from idea to appearance in store is fifteen days versus their rivals who receive new styles once or twice a season. Smaller tweaks arrive even faster. If enough customers come in and ask for a round neck instead of a V neck, a new version can be in stores with in just ten days.J. Tagliabue, “A Rival to Gap That Operates Like Dell,” New York Times, May 30, 2003. To put that in perspective, Zara is twelve times faster than Gap despite offering roughly ten times more unique products!M. Helft, “Fashion Fast Forward,” Business 2.0, May 2002. At H&M, it takes three to five months to go from creation to delivery—and they’re considered one of the best. Other retailers need an average of six months to design a new collection and then another three months to manufacture it. VF Corp (Lee, Wrangler) can take nine months just to design a pair of jeans, while J. Jill needs a year to go from concept to store shelves.L. Sullivan, “Designed to Cut Time,” InformationWeek, February 28, 2005. At Zara, most of the products you see in stores didn’t exist three weeks earlier, not even as sketches.J. Surowiecki, “The Most Devastating Retailer in the World,” New Yorker, September 18, 2000.

The firm is able to be so responsive through a competitor-crushing combination of vertical integrationWhen a single firm owns several layers in its value chain. and technology-orchestrated coordination of suppliers, just-in-time manufacturing, and finely tuned logistics. Vertical integration is when a single firm owns several layers in its value chainThe set of activities through which a product or service is created and delivered to customers..Definition from the “father” of the value chain, Michael Porter. See M. Porter, “Strategy and the Internet,” Harvard Business Review 79, no. 3 (March 2001): 62–78, among others. While H&M has nine hundred suppliers and no factories, nearly 60 percent of Zara’s merchandise is produced in-house, with an eye on leveraging technology in those areas that speed up complex tasks, lower cycle time, and reduce error. Profits from this clothing retailer come from blending math with a data-driven fashion sense. Inventory optimization models help the firm determine how many of which items in which sizes should be delivered to each specific store during twice-weekly shipments, ensuring that each store is stocked with just what it needs.C. Gentry, “European Fashion Stores Edge Past U.S. Counterparts,” Chain Store Age, December 2007. Outside the distribution center in La Coruña, fabric is cut and dyed by robots in twenty-three highly automated factories. Zara is so vertically integrated, the firm makes 40 percent of its own fabric and purchases most of its dyes from its own subsidiary. Roughly half of the cloth arrives undyed so the firm can respond as any midseason fashion shifts occur. After cutting and dying, many items are stitched together through a network of local cooperatives that have worked with Inditex so long they don’t even operate with written contracts. The firm does leverage contract manufacturers (mostly in Turkey and Asia) to produce staple items with longer shelf lives, such as t-shirts and jeans, but such goods account for only about one-eighth of dollar volume.N. Tokatli, “Global Sourcing: Insights from the Global Clothing Industry—The Case of Zara, a Fast Fashion Retailer,” Journal of Economic Geography 8, no. 1 (2008): 21–38.

All of the items the firm sells end up in a five-million-square-foot distribution center in La Coruña, or a similar facility in Zaragoza in the northeast of Spain. The La Coruña facility is some nine times the size of Amazon’s warehouse in Fernley, Nevada, or about the size of ninety football fields.M. Helft, “Fashion Fast Forward,” Business 2.0, May 2002. The facilities move about two and a half million items every week, with no item staying in-house for more than seventy-two hours. Ceiling-mounted racks and customized sorting machines patterned on equipment used by overnight parcel services, and leveraging Toyota-designed logistics, whisk items from factories to staging areas for each store. Clothes are ironed in advance and packed on hangers, with security and price tags affixed. This system means that instead of wrestling with inventory during busy periods, employees in Zara stores simply move items from shipping box to store racks, spending most of their time on value-added functions like helping customers find what they want. Efforts like this help store staff regain as much as three hours in prime selling time.C. Rohwedder and K. Johnson, “Pace-Setting Zara Seeks More Speed to Fight Its Rising Cheap-Chic Rivals,” Wall Street Journal, February 20, 2008; and K. Capell, “Zara Thrives by Breaking All the Rules,” BusinessWeek, October 9, 2008.

Trucks serve destinations that can be reached overnight, while chartered cargo flights serve farther destinations within forty-eight hours.K. Capell, “Zara Thrives by Breaking All the Rules,” BusinessWeek, October 9, 2008. The firm recently tweaked its shipping models through Air France–KLM Cargo and Emirates Air so flights can coordinate outbound shipment of all Inditex brands with return legs loaded with raw materials and half-finished clothes items from locations outside of Spain. Zara is also a pioneer in going green. In fall 2007, the firm’s CEO unveiled an environmental strategy that includes the use of renewable energy systems at logisticsCoordinating and enabling the flow of goods, people, information, and other resources among locations. centers including the introduction of biodiesel for the firm’s trucking fleet.

Stores

Most products are manufactured for a limited production run. While running out of bestsellers might be seen as a disaster at most retailers, at Zara the practice delivers several benefits.

First, limited runs allow the firm to cultivate the exclusivity of its offerings. While a Gap in Los Angeles carries nearly the same product line as one in Milwaukee, each Zara store is stocked with items tailored to the tastes of its local clientele. A Fifth Avenue shopper quips, “At Gap, everything is the same,” while a Zara shopper in Madrid says, “You’ll never end up looking like someone else.”K. Capell, “Fashion Conquistador,” BusinessWeek, September 4, 2006. Upon visiting a Zara, the CEO of the National Retail Federation marveled, “It’s like you walk into a new store every two weeks.”M. Helft, “Fashion Fast Forward,” Business 2.0, May 2002.

Second, limited runs encourage customers to buy right away and at full price. Savvy Zara shoppers know the newest items arrive on black plastic hangers, with store staff transferring items to wooden ones later on. Don’t bother asking when something will go on sale; if you wait three weeks the item you wanted has almost certainly been sold or moved out to make room for something new. Says one twenty-three year-old Barcelona shopper, “If you see something and don’t buy it, you can forget about coming back for it because it will be gone.”K. Capell, “Fashion Conquistador,” BusinessWeek, September 4, 2006. A study by consulting firm Bain & Company estimated that the industry average markdown ratio is approximately 50 percent, while Zara books some 85 percent of its products at full price.D. Sull and S. Turconi, “Fast Fashion Lessons,” Business Strategy Review, Summer 2008; and K. Capell, “Fashion Conquistador,” BusinessWeek, September 4, 2006.

The constant parade of new, limited-run items also encourages customers to visit often. The average Zara customer visits the store seventeen times per year, compared with only three annual visits made to competitors.N. Kumar and S. Linguri, “Fashion Sense,” Business Strategy Review, Summer 2006. Even more impressive—Zara puts up these numbers with almost no advertising. The firm’s founder has referred to advertising as a “pointless distraction.” The assertion carries particular weight when you consider that during Gap’s collapse, the firm increased advertising spending but sales dropped.P. Bhatnagar, “How Do You Ad(dress) the Gap?” Fortune, October 11, 2004. Fashion retailers spend an average of 3.5 percent of revenue promoting their products, while ad spending at Inditex is just 0.3 percent.“Zara, A Spanish Success Story,” CNN.com, June 15, 2001, http://edition.cnn.com/BUSINESS/programs/yourbusiness/stories2001/zara.

Finally, limited production runs allow the firm to, as Zara’s CEO once put it, “reduce to a minimum the risk of making a mistake, and we do make mistakes with our collections.”C. Vitzthum, “Zara’s Success Lies in Low-Cost Lines and a Rapid Turnover of Collections,” Wall Street Journal, May 18, 2001. Failed product introductions are reported to be just 1 percent, compared with the industry average of 10 percent.N. Kumar and S. Linguri, “Fashion Sense,” Business Strategy Review, Summer 2006. So even though Zara has higher manufacturing costs than rivals, Inditex gross margins are 56.8 percent compared to 37.5 percent at Gap.C. Rohwedder, “Zara Grows as Retail Rivals Struggle,” Wall Street Journal, March 26, 2009. For labor cost comparison, K. Capell, “Zara Thrives by Breaking All the Rules,” BusinessWeek, October 9, 2008, reports that workers in Spain earn an average of $1,650/month versus $206/month in China’s Guangdong Province.

While stores provide valuable front-line data, headquarters plays a major role in directing in-store operations. Software is used to schedule staff based on each store’s forecasted sales volume, with locations staffing up at peak times such as lunch or early evening. The firm claims these more flexible schedules have shaved staff work hours by 2 percent. This constant refinement of operations throughout the firm’s value chain has helped reverse a prior trend of costs rising faster than sales.C. Rohwedder and K. Johnson, “Pace-Setting Zara Seeks More Speed to Fight Its Rising Cheap-Chic Rivals,” Wall Street Journal, February 20, 2008.

Even the store displays are directed from “The Cube,” where a basement staging area known as “Fashion Street” houses a Potemkin village of bogus storefronts meant to mimic some of the chain’s most exclusive locations throughout the world. It’s here that workers test and fine-tune the chain’s award-winning window displays, merchandise layout, and even determine the in-store soundtrack. Every two weeks, new store layout marching orders are forwarded to managers at each location.C. Rohwedder and K. Johnson, “Pace-Setting Zara Seeks More Speed to Fight Its Rising Cheap-Chic Rivals,” Wall Street Journal, February 20, 2008.

The Danger of Relying on Technology

Firms strive for sustainable competitive advantageFinancial performance that consistently outperforms industry averages., financial performance that consistently outperforms their industry peers. The goal is easy to state, but hard to achieve. The world is so dynamic, with new products and new competitors rising seemingly overnight, that truly sustainable advantage might seem like an impossibility. New competitors and copycat products create a race to cut costs, cut prices, and increase features that may benefit consumers but erode profits industry-wide. Nowhere is this balance more difficult than when competition involves technology. The fundamental strategic question in the Internet era is, “How can I possibly compete when everyone can copy my technology and the competition is just a click away?” Put that way, the pursuit of sustainable competitive advantage seems like a lost cause.

But there are winners—big, consistent winners—empowered through their use of technology. How do they do it? In order to think about how to achieve sustainable advantage, it’s useful to start with two concepts defined by Michael Porter. A professor at the Harvard Business School and father of the value chain and the five forces concepts (see the sections later in this chapter), Porter is justifiably considered one of the leading strategic thinkers of our time.

According to Porter, the reason so many firms suffer aggressive, margin-eroding competition is because they’ve defined themselves according to operational effectiveness rather than strategic positioning. Operational effectivenessPerforming the same tasks better than rivals perform them. refers to performing the same tasks better than rivals perform them. Everyone wants to be better, but the danger in operational effectiveness is “sameness.” This risk is particularly acute in firms that rely on technology for competitiveness. After all, technology can be easily acquired. Buy the same stuff as your rivals, hire students from the same schools, copy the look and feel of competitor Web sites, reverse engineer their products, and you can match them. The fast follower problemExists when savvy rivals watch a pioneer’s efforts, learn from their successes and missteps, then enter the market quickly with a comparable or superior product at a lower cost before the first mover can dominate. exists when savvy rivals watch a pioneer’s efforts, learn from their successes and missteps, then enter the market quickly with a comparable or superior product at a lower cost.

Since tech can be copied so quickly, followers can be fast, indeed. Several years ago while studying the Web portal industry (Yahoo! and its competitors), a colleague and I found that when a firm introduced an innovative feature, at least one of its three major rivals would match that feature in, on average, only one and a half months.J. Gallaugher and C. Downing, “Portal Combat: An Empirical Study of Competition in the Web Portal Industry,” Journal of Information Technology Management 11, no. 1–2 (2000): 13–24. When technology can be matched so quickly, it is rarely a source of competitive advantage. And this phenomenon isn’t limited to the Web.

Tech giant EMC saw its stock price appreciate more than any other firm during the decade of the 1990s. However, when IBM and Hitachi entered the high-end storage market with products comparable to EMC’s Symmetrix unit, prices plunged 60 percent the first year and another 35 percent the next.P. Engardio and F. F. Keenan, “The Copycat Economy,” BusinessWeek, August 26, 2002. Needless to say, EMC’s stock price took a comparable beating. TiVo is another example. At first blush, it looks like this first mover should be a winner since it seems to have established a leading brand; TiVo is now a verb for digitally recording TV broadcasts. But despite this, TiVo has largely been a money loser, going years without posting an annual profit. And while 1.5 million TiVos have been sold, there are over thirty million digital video recorders (DVRs) in use.N. DiMeo, “TiVo’s Goal with New DVR: Become the Google of TV,” Morning Edition, National Public Radio, April 7, 2010. Rival devices offered by cable and satellite companies appear the same to consumers, and are offered along with pay television subscriptions—a critical distribution channel for reaching customers that TiVo doesn’t control.

Operational effectiveness is critical. Firms must invest in techniques to improve quality, lower cost, and generate design-efficient customer experiences. But for the most part, these efforts can be matched. Because of this, operational effectiveness is usually not sufficient enough to yield sustainable dominance over the competition. In contrast to operational effectiveness, strategic positioningPerforming different tasks than rivals, or the same tasks in a different way. refers to performing different activities from those of rivals, or the same activities in a different way. While technology itself is often very easy to replicate, technology is essential to creating and enabling novel approaches to business that are defensibly different from those of rivals and can be quite difficult for others to copy.

Different Is Good: FreshDirect Redefines the NYC Grocery Landscape

For an example of the relationship between technology and strategic positioning, consider FreshDirect. The New York City–based grocery firm focused on the two most pressing problems for Big Apple shoppers: selection is limited and prices are high. Both of these problems are a function of the high cost of real estate in New York. The solution? Use technology to craft an ultraefficient model that makes an end-run around stores.

The firm’s “storefront” is a Web site offering one-click menus, semiprepared specials like “meals in four minutes,” and the ability to pull up prior grocery lists for fast reorders—all features that appeal to the time-strapped Manhattanites who were the firm’s first customers. (The Web’s not the only channel to reach customers—the firm’s iPhone app was responsible for 2.5 percent of sales just weeks after launch.)R. M. Schneiderman, “FreshDirect Goes to Greenwich,” Wall Street Journal, April 6, 2010. Next-day deliveries are from a vast warehouse the size of five football fields located in a lower-rent industrial area of Queens. At that size, the firm can offer a fresh goods selection that’s over five times larger than local supermarkets. Area shoppers—many of whom don’t have cars or are keen to avoid the traffic-snarled streets of the city—were quick to embrace the model. The service is now so popular that apartment buildings in New York have begun to redesign common areas to include secure freezers that can accept FreshDirect deliveries, even when customers aren’t there.L. Croghan, “Food Latest Luxury Lure,” New York Daily News, March 12, 2006.

The FreshDirect model crushes costs that plague traditional grocers. Worker shifts are highly efficient, avoiding the downtime lulls and busy rush hour spikes of storefronts. The result? Labor costs that are 60 percent lower than at traditional grocers. FreshDirect buys and prepares what it sells, leading to less waste, an advantage that the firm claims is “worth 5 percentage points of total revenue in terms of savings.”P. Fox, “Interview with FreshDirect Co-Founder Jason Ackerman,” Bloomberg Television, June 17, 2009. Overall perishable inventory at FreshDirect turns 197 times a year versus 40 times a year at traditional grocers.E. Schonfeld, “The Big Cheese of Online Grocers Joe Fedele’s Inventory-Turning Ideas May Make FreshDirect the First Big Web Supermarket to Find Profits,” Business 2.0, January 1, 2004. Higher inventory turnsSometimes referred to as inventory turnover, stock turns, or stock turnover. It is the number of times inventory is sold or used during the course of a year. A higher figure means that a firm is selling products quickly. mean the firm is selling product faster, so it collects money quicker than its rivals do. And those goods are fresher since they’ve been in stock for less time, too. Consider that while the average grocer may have seven to nine days of seafood inventory, FreshDirect’s seafood stock turns each day. Stock is typically purchased direct from the docks in order to fulfill orders placed less than twenty-four hours earlier.T. Laseter, B. Berg, and M. Turner, “What FreshDirect Learned from Dell,” Strategy+Business, February 12, 2003.

Artificial intelligence software, coupled with some seven miles of fiber-optic cables linking systems and sensors, supports everything from baking the perfect baguette to verifying orders with 99.9 percent accuracy.J. Black, “Can FreshDirect Bring Home the Bacon?” BusinessWeek, September 24, 2002; S. Sieber and J. Mitchell, “FreshDirect: Online Grocery that Actually Delivers!” IESE Insight, 2007. Since it lacks the money-sucking open-air refrigerators of the competition, the firm even saves big on energy (instead, staff bundle up for shifts in climate-controlled cold rooms tailored to the specific needs of dairy, deli, and produce). And a new initiative uses recycled biodiesel fuel to cut down on delivery costs.

FreshDirect buys directly from suppliers, eliminating middlemen wherever possible. The firm also offers suppliers several benefits beyond traditional grocers, all in exchange for more favorable terms. These include offering to carry a greater selection of supplier products while eliminating the “slotting fees” (payments by suppliers for prime shelf space) common in traditional retail, cobranding products to help establish and strengthen supplier brand, paying partners in days rather than weeks, and sharing data to help improve supplier sales and operations. Add all these advantages together and the firm’s big, fresh selection is offered at prices that can undercut the competition by as much as 35 percent.H. Green, “FreshDirect,” BusinessWeek, November 24, 2003. And FreshDirect does it all with margins in the range of 20 percent (to as high as 45 percent on many semiprepared meals), easily dwarfing the razor-thin 1 percent margins earned by traditional grocers.S. Sieber and J. Mitchell, “FreshDirect: Online Grocery that Actually Delivers!” IESE Insight, 2007; D. Kirkpatrick, “The Online Grocer Version 2.0,” Fortune, November 25, 2002; P. Fox, “Interview with FreshDirect Co-Founder Jason Ackerman,” Bloomberg Television, June 17, 2009.

Today, FreshDirect serves a base of some 600,000 paying customers. That’s a population roughly the size of metro-Boston, serviced by a single grocer with no physical store. The privately held firm has been solidly profitable for several years. Even in recession-plagued 2009, the firm’s CEO described 2009 earnings as “pretty spectacular,”P. Fox, “Interview with FreshDirect Co-Founder Jason Ackerman,” Bloomberg Television, June 17, 2009. while 2010 revenues are estimated to grow to roughly $300 million.R. M. Schneiderman, “FreshDirect Goes to Greenwich,” Wall Street Journal, April 6, 2010.

Technology is critical to the FreshDirect model, but it’s the collective impact of the firm’s differences when compared to rivals, this tech-enabled strategic positioning, that delivers success. Operating for more than half a decade, the firm has also built up a set of strategic assets that not only address specific needs of a market but are now extremely difficult for any upstart to compete against. Traditional grocers can’t fully copy the firm’s delivery business because this would leave them straddlingAttempts to occupy more than one position, while failing to match the benefits of a more efficient, singularly focused rival. two markets (low-margin storefront and high-margin delivery), unable to gain optimal benefits from either. Entry costs for would-be competitors are also high (the firm spent over $75 million building infrastructure before it could serve a single customer), and the firm’s complex and highly customized software, which handles everything from delivery scheduling to orchestrating the preparation of thousands of recipes, continues to be refined and improved each year.C. Valerio, “Interview with FreshDirect Co-Founder Jason Ackerman,” Venture, Bloomberg Television, September 18, 2009. On top of all this comes years of customer data used to further refine processes, speed reorders, and make helpful recommendations. Competing against a firm with such a strong and tough-to-match strategic position can be brutal. Just five years after launch there were one-third fewer supermarkets in New York City than when FreshDirect first opened for business.R. Shulman, “Groceries Grow Elusive for Many in New York City,” Washington Post, February 19, 2008.

But What Kinds of Differences?

The principles of operational effectiveness and strategic positioning are deceptively simple. But while Porter claims strategy is “fundamentally about being different,”M. Porter, “What Is Strategy?” Harvard Business Review 74, no. 6 (November–December 1996): 61–78. how can you recognize whether your firm’s differences are special enough to yield sustainable competitive advantage?

An approach known as the resource-based view of competitive advantageThe strategic thinking approach suggesting that if a firm is to maintain sustainable competitive advantage, it must control an exploitable resource, or set of resources, that have four critical characteristics. These resources must be (1) valuable, (2) rare, (3) imperfectly imitable, and (4) nonsubstitutable. can help. The idea here is that if a firm is to maintain sustainable competitive advantage, it must control a set of exploitable resources that have four critical characteristics. These resources must be (1) valuable, (2) rare, (3) imperfectly imitable (tough to imitate), and (4) nonsubstitutable. Having all four characteristics is key. Miss value and no one cares what you’ve got. Without rareness, you don’t have something unique. If others can copy what you have, or others can replace it with a substitute, then any seemingly advantageous differences will be undercut.

Strategy isn’t just about recognizing opportunity and meeting demand. Resource-based thinking can help you avoid the trap of carelessly entering markets simply because growth is spotted. The telecommunications industry learned this lesson in a very hard and painful way. With the explosion of the Internet it was easy to see that demand to transport Web pages, e-mails, MP3s, video, and everything else you can turn into ones and zeros, was skyrocketing.

Most of what travels over the Internet is transferred over long-haul fiber-optic cables, so telecom firms began digging up the ground and laying webs of fiberglass to meet the growing demand. Problems resulted because firms laying long-haul fiber didn’t fully appreciate that their rivals and new upstart firms were doing the exact same thing. By one estimate there was enough fiber laid to stretch from the Earth to the moon some 280 times!L. Kahney, “Net Speed Ain’t Seen Nothin’ Yet,” Wired News, March 21, 2000. On top of that, a technology called dense wave division multiplexing (DWDM)A technology that increases the transmission capacity (and hence speed) of fiber-optic cable. Transmissions using fiber are accomplished by transmitting light inside “glass” cables. In DWDM, the light inside fiber is split into different wavelengths in a way similar to how a prism splits light into different colors. enabled existing fiber to carry more transmissions than ever before. The end result—these new assets weren’t rare and each day they seemed to be less valuable.

For some firms, the transmission prices they charged on newly laid cable collapsed by over 90 percent. Established firms struggled, upstarts went under, and WorldCom became the biggest bankruptcy in U.S. history. The impact was felt throughout all industries that supplied the telecom industry. Firms like Sun, Lucent, and Nortel, whose sales growth relied on big sales to telecom carriers, saw their value tumble as orders dried up. Estimates suggest that the telecommunications industry lost nearly $4 trillion in value in just three years,L. Endlich, Optical Illusions: Lucent and the Crash of Telecom (New York: Simon & Schuster, 2004). much of it due to executives that placed big bets on resources that weren’t strategic.

Imitation-Resistant Value Chains

While many of the resources below are considered in isolation, the strength of any advantage can be far more significant if firms are able to leverage several of these resources in a way that makes each stronger and makes the firm’s way of doing business more difficult for rivals to match. Firms that craft an imitation-resistant value chainA way of doing business that competitors struggle to replicate and that frequently involves technology in a key enabling role. have developed a way of doing business that others will struggle to replicate, and in nearly every successful effort of this kind, technology plays a key enabling role. The value chain is the set of interrelated activities that bring products or services to market (see below). When we compare FreshDirect’s value chain to traditional rivals, there are differences across every element. But most importantly, the elements in FreshDirect’s value chain work together to create and reinforce competitive advantages that others cannot easily copy. Incumbents would be straddled between two business models, unable to reap the full advantages of either. And late-moving pure-play rivals will struggle, as FreshDirect’s lead time allows the firm to develop brand, scale, data, and other advantages that newcomers lack (see below for more on these resources).

Brand

A firm’s brandThe symbolic embodiment of all the information connected with a product or service. is the symbolic embodiment of all the information connected with a product or service, and a strong brand can also be an exceptionally powerful resource for competitive advantage. Consumers use brands to lower search costs, so having a strong brand is particularly vital for firms hoping to be the first online stop for consumers. Want to buy a book online? Auction a product? Search for information? Which firm would you visit first? Almost certainly Amazon, eBay, or Google. But how do you build a strong brand? It’s not just about advertising and promotion. First and foremost, customer experience counts. A strong brand proxies quality and inspires trust, so if consumers can’t rely on a firm to deliver as promised, they’ll go elsewhere. As an upside, tech can play a critical role in rapidly and cost-effectively strengthening a brand. If a firm performs well, consumers can often be enlisted to promote a product or service (so-called viral marketingLeveraging consumers to promote a product or service.). Consider that while scores of dot-coms burned through money on Super Bowl ads and other costly promotional efforts, Google, Hotmail, Skype, eBay, MySpace, Facebook, Twitter, YouTube, and so many other dominant online properties built multimillion member followings before committing any significant spending to advertising.

Early customer accolades for a novel service often mean that positive press (a kind of free advertising) will also likely follow.

But show up late and you may end up paying much more to counter an incumbent’s place in the consumer psyche. In recent years, Amazon has spent no money on television advertising, while rivals Buy.com and Overstock.com spent millions. Google, another strong brand, has become a verb, and the cost to challenge it is astonishingly high. Yahoo! and Microsoft’s Bing each spent $100 million on Google-challenging branding campaigns, but the early results of these efforts seemed to do little to grow share at Google’s expense.J. Edwards, “JWT’s $100 Million Campaign for Microsoft’s Bing Is Failing,” BNET, July 16, 2009. Branding is difficult, but if done well, even complex tech products can establish themselves as killer brands. Consider that Intel has taken an ingredient product that most people don’t understand, the microprocessor, and built a quality-conveying name recognized by computer users worldwide.

Scale

Many firms gain advantages as they grow in size. Advantages related to a firm’s size are referred to as scale advantagesAdvantages related to size.. Businesses benefit from economies of scaleWhen costs can be spread across increasing units of production or in serving multiple customers. Businesses that have favorable economies of scale (like many Internet firms) are sometimes referred to as being highly scalable. when the cost of an investment can be spread across increasing units of production or in serving a growing customer base. Firms that benefit from scale economies as they grow are sometimes referred to as being scalable. Many Internet and tech-leveraging businesses are highly scalable since, as firms grow to serve more customers with their existing infrastructure investment, profit margins improve dramatically.

Consider that in just one year, the Internet firm BlueNile sold as many diamond rings with just 115 employees and one Web site as a traditional jewelry retailer would sell through 116 stores.T. Mullaney, “Jewelry Heist,” BusinessWeek, May 10, 2004. And with lower operating costs, BlueNile can sell at prices that brick-and-mortar stores can’t match, thereby attracting more customers and further fueling its scale advantages. Profit margins improve as the cost to run the firm’s single Web site and operate its one warehouse is spread across increasing jewelry sales.

A growing firm may also gain bargaining power with its suppliers or buyers. As Dell grew larger, the firm forced suppliers wanting in on Dell’s growing business to make concessions such as locating close to Dell plants. Similarly, for years eBay could raise auction fees because of the firm’s market dominance. Auction sellers who left eBay lost pricing power since fewer bidders on smaller, rival services meant lower prices.

The scale of technology investment required to run a business can also act as a barrier to entry, discouraging new, smaller competitors. Intel’s size allows the firm to pioneer cutting-edge manufacturing techniques and invest $7 billion on next-generation plants.J. Flatley, “Intel Invests $7 Billion in Stateside 32nm Manufacturing,” Engadget, February 10, 2009. And although Google was started by two Stanford students with borrowed computer equipment running in a dorm room, the firm today runs on an estimated 1.4 million servers.R. Katz, “Tech Titans Building Boom,” IEEE Spectrum 46, no. 2 (February 1, 2009): 40–43. The investments being made by Intel and Google would be cost-prohibitive for almost any newcomer to justify.

Switching Costs and Data

Switching costsThe cost a consumer incurs when moving from one product to another. It can involve actual money spent (e.g., buying a new product) as well as investments in time, any data loss, and so forth. exist when consumers incur an expense to move from one product or service to another. Tech firms often benefit from strong switching costs that cement customers to their firms. Users invest their time learning a product, entering data into a system, creating files, and buying supporting programs or manuals. These investments may make them reluctant to switch to a rival’s effort.

Similarly, firms that seem dominant but that don’t have high switching costs can be rapidly trumped by strong rivals. Netscape once controlled more than 80 percent of the market share in Web browsers, but when Microsoft began bundling Internet Explorer with the Windows operating system and (through an alliance) with America Online (AOL), Netscape’s market share plummeted. Customers migrated with a mouse click as part of an upgrade or installation. Learning a new browser was a breeze, and with the Web’s open standards, most customers noticed no difference when visiting their favorite Web sites with their new browser.

It is critical for challengers to realize that in order to win customers away from a rival, a new entrant must not only demonstrate to consumers that an offering provides more value than the incumbent, they have to ensure that their value added exceeds the incumbent’s value plus any perceived customer switching costs (see Figure 2.4). If it’s going to cost you and be inconvenient, there’s no way you’re going to leave unless the benefits are overwhelming.

Data can be a particularly strong switching cost for firms leveraging technology. A customer who enters her profile into Facebook, movie preferences into Netflix, or grocery list into FreshDirect may be unwilling to try rivals—even if these firms are cheaper—if moving to the new firm means she’ll lose information feeds, recommendations, and time savings provided by the firms that already know her well. Fueled by scale over time, firms that have more customers and have been in business longer can gather more data, and many can use this data to improve their value chain by offering more accurate demand forecasting or product recommendations.

Differentiation

Commodities are products or services that are nearly identically offered from multiple vendors. Consumers buying commodities are highly price-focused since they have so many similar choices. In order to break the commodity trap, many firms leverage technology to differentiate their goods and services. Dell gained attention from customers not only because of its low prices, but also because it was one of the first PC vendors to build computers based on customer choice. Want a bigger hard drive? Don’t need the fast graphics card? Dell will oblige.

Technology has allowed Lands’ End to take this concept to clothing. Now 40 percent of the firm’s chino and jeans orders are for custom products, and consumers pay a price markup of one-third or more for the tailored duds.J. Schlosser, “Cashing In on the New World of Me,” Fortune, December 1, 2004. This kind of tech-led differentiation creates and reinforces other assets. While rivals also offer custom products, Lands’ End has established a switching cost with its customers, since moving to rivals would require twenty minutes to reenter measurements and preferences versus two minutes to reorder from LandsEnd.com. The firm’s reorder rates are 40 to 60 percent on custom clothes, and Lands’ End also gains valuable information on more accurate sizing—critical because current clothes sizes provided across the U.S. apparel industry comfortably fit only about one-third of the population.

Data is not only a switching cost, it also plays a critical role in differentiation. Each time a visitor returns to Amazon, the firm uses browsing records, purchase patterns, and product ratings to present a custom home page featuring products that the firm hopes the visitor will like. Customers value the experience they receive at Amazon so much that the firm received the highest score ever recorded on the University of Michigan’s American Customer Satisfaction Index (ACSI). The score was not just the highest performance of any online firm, it was the highest ranking that any service firm in any industry had ever received.

Capital One has also used data to differentiate its offerings. The firm mines data and runs experiments to create risk models on potential customers. Because of this, the credit card firm aggressively pursued a set of customers that other lenders considered too risky based on simplistic credit scoring. Technology determined that these underserved customers not properly identified by conventional techniques were actually good bets. Finding profitable new markets that others ignored allowed Capital One to grow its EPS (earnings per share) 20 percent a year for seven years, a feat matched by less than 1 percent of public firms.T. Davenport and J. Harris, Competing on Analytics: The New Science of Winning (Boston: Harvard Business School Press, 2007).

Network Effects

AOL’s instant messaging client, AIM, has the majority of instant messaging users in the United States. Microsoft Windows has a 90 percent market share in operating systems. EBay has an 80 percent share of online auctions. Why are these firms so dominant? Largely due to the concept of network effectsAlso known as Metcalfe’s Law, or network externalities. When the value of a product or service increases as its number of users expands. (see Chapter 6 “Understanding Network Effects”). Network effects (sometimes called network externalities or Metcalfe’s Law) exist when a product or service becomes more valuable as more people use it. If you’re the first person with an AIM account, then AIM isn’t very valuable. But with each additional user, there’s one more person to chat with. A firm with a big network of users might also see value added by third parties. Sony’s PlayStation 2 dominated the prior generation of video game consoles in large part because it had more games than its rivals, and most of these games were provided by firms other than Sony. Third-party add-on products, books, magazines, or even skilled labor are all attracted to networks of the largest number of users, making dominant products more valuable.

Switching costs also play a role in determining the strength of network effects. Tech user investments often go far beyond simply the cost of acquiring a technology. Users spend time learning a product; they buy add-ons, create files, and enter preferences. Because no one wants to be stranded with an abandoned product and lose this additional investment, users may choose a technically inferior product simply because the product has a larger user base and is perceived as having a greater chance of being offered in the future. The virtuous cycle of network effectsA virtuous adoption cycle occurs when network effects exist that make a product or service more attractive (increases benefits, reduces costs) as the adopter base grows. doesn’t apply to all tech products, and it can be a particularly strong asset for firms that can control and leverage a leading standard (think Apple’s iPhone and iPad with their closed systems versus Netscape, which was almost entirely based on open standards), but in some cases where network effects are significant, they can create winners so dominant that firms with these advantages enjoy a near-monopoly hold on a market.

Distribution Channels

If no one sees your product, then it won’t even get considered by consumers. So distribution channelsThe path through which products or services get to customers.—the path through which products or services get to customers—can be critical to a firm’s success. Again, technology opens up opportunities for new ways to reach customers.

Users can be recruited to create new distribution channels for your products and services (usually for a cut of the take). You may have visited Web sites that promote books sold on Amazon.com. Web site operators do this because Amazon gives them a percentage of all purchases that come in through these links. Amazon now has over 1 million of these “associates” (the term the firm uses for its affiliatesThird parties that promote a product or service, typically in exchange for a cut of any sales.), yet it only pays them if a promotion gains a sale. Google similarly receives some 30 percent of its ad revenue not from search ads, but from advertisements distributed within third-party sites ranging from lowly blogs to the New York Times.Google Fourth Quarter 2008 Earnings Summary, http://investor.google.com/earnings.html.

In recent years, Google and Microsoft have engaged in bidding wars, trying to lock up distribution deals that would bundle software tools, advertising, or search capabilities with key partner offerings. Deals with partners such as Dell, MySpace, and Verizon Wireless have been valued at up to $1 billion each.N. Wingfield, “Microsoft Wins Key Search Deals,” Wall Street Journal, January 8, 2009.

The ability to distribute products by bundling them with existing offerings is a key Microsoft advantage. But beware—sometimes these distribution channels can provide firms with such an edge that international regulators have stepped in to try to provide a more level playing field. Microsoft was forced by European regulators to unbundle the Windows Media Player, for fear that it provided the firm with too great an advantage when competing with the likes of RealPlayer and Apple’s QuickTime (see Chapter 6 “Understanding Network Effects”).

What about Patents?

Intellectual property protection can be granted in the form of a patent for those innovations deemed to be useful, novel, and nonobvious. In the United States, technology and (more controversially) even business models can be patented, typically for periods of twenty years from the date of patent application. Firms that receive patents have some degree of protection from copycats that try to identically mimic their products and methods.

The patent system is often considered to be unfairly stacked against start-ups. U.S. litigation costs in a single patent case average about $5 million,B. Feld, “Why the Decks Are Stacked against Software Startups in Patent Litigation,” Technology Review, April 12, 2009. and a few months of patent litigation can be enough to sink an early stage firm. Large firms can also be victims. So-called patent trolls hold intellectual property not with the goal of bringing novel innovations to market but instead in hopes that they can sue or extort large settlements from others. BlackBerry maker Research in Motion’s $612 million settlement with the little-known holding company NTP is often highlighted as an example of the pain trolls can inflict.T. Wu, “Weapons of Business Destruction,” Slate, February 6, 2006; R. Kelley, “BlackBerry Maker, NTP Ink $612 Million Settlement,” CNN Money, March 3, 2006.

Even if an innovation is patentable, that doesn’t mean that a firm has bulletproof protection. Some patents have been nullified by the courts upon later review (usually because of a successful challenge to the uniqueness of the innovation). Software patents are also widely granted, but notoriously difficult to defend. In many cases, coders at competing firms can write substitute algorithms that aren’t the same, but accomplish similar tasks. For example, although Google’s PageRank search algorithms are fast and efficient, Microsoft, Yahoo! and others now offer their own noninfringing search that presents results with an accuracy that many would consider on par with PageRank. Patents do protect tech-enabled operations innovations at firms like Netflix and Harrah’s (casino hotels), and design innovations like the iPod click wheel. But in a study of the factors that were critical in enabling firms to profit from their innovations, Carnegie Mellon professor Wes Cohen found that patents were only the fifth most important factor. Secrecy, lead time, sales skills, and manufacturing all ranked higher.T. Mullaney and S. Ante, “InfoWars,” BusinessWeek, June 5, 2000.

Finance

Many business school students who study finance aspire to careers in investment banking. Many i-bankers will work on IPOs, or initial public stock offerings, in effect helping value companies the first time these firms wish to sell their stock on the public markets. IPO markets need new firms, and the tech industry is a fertile ground that continually sprouts new businesses like no other. Other i-bankers will be involved in valuing merger and acquisition (M&A) deals, and tech firms are active in this space, too. Leading tech firms are flush with cash and constantly on the hunt for new firms to acquire. Cisco bought forty-eight firms in the prior decade; Oracle bought five firms in 2009 alone. And even in nontech industries, technology impacts nearly every endeavor as an opportunity catalyst or a disruptive wealth destroyer. The aspiring investment banker who doesn’t understand the role of technology in firms and industries can’t possibly provide an accurate guess at how much a company is worth.

Those in other finance careers will be lending to tech firms and evaluating the role of technology in firms in an investment portfolio. Most of you will want to consider tech’s role as part of your personal investments. And modern finance simply wouldn’t exist without tech. When someone arranges for a bridge to be built in Shanghai, those funds aren’t carried over in a suitcase—they’re digitally transferred from bank to bank. And forces of technology blasted open the two-hundred-year-old floor trading mechanism of the New York Stock Exchange, in effect forcing the NYSE to sell shares in itself to finance the acquisition of technology-based trading platforms that were threatening to replace it. As another example of the importance of tech in finance, consider that Boston-based Fidelity Investments, one of the nation’s largest mutual fund firms, spends roughly $2.8 billion a year on technology. Tech isn’t a commodity for finance—it’s the discipline’s lifeblood.

Accounting

If you’re an accountant, your career is built on a foundation of technology. The numbers used by accountants are all recorded, stored, and reported by information systems, and the reliability of any audit is inherently tied to the reliability of the underlying technology. Increased regulation, such as the heavy executive penalties tied to the Sarbanes-Oxley ActAlso known as Sarbox or SOX; U.S. legislation enacted in the wake of the accounting scandals of the early 2000s. The act raises executive and board responsibility and ties criminal penalties to certain accounting and financial violations. Although often criticized, SOX is also seen as raising stakes for mismanagement and misdeeds related to a firm’s accounting practices. in the United States, have ratcheted up the importance of making sure accountants (and executives) get their numbers right. Negligence could mean jail time. This means the link between accounting and tech have never been tighter, and the stakes for ensuring systems accuracy have never been higher.

Business students might also consider that while accounting firms regularly rank near the top of BusinessWeek’s “Best Places to Start Your Career” list, many of the careers at these firms are highly tech-centric. Every major accounting firm has spawned a tech-focused consulting practice, and in many cases, these firms have grown to be larger than the accounting services functions from which they sprang. Today, Deloitte’s tech-centric consulting division is larger than the firm’s audit, tax, and risk practices. At the time of its spin-off, Accenture was larger than the accounting practice at former parent Arthur Andersen (Accenture executives are also grateful they split before Andersen’s collapse in the wake of the prior decade’s accounting scandals). Now, many accounting firms that had previously spun off technology practices are once again building up these functions, finding strong similarities between the skills of an auditor and skills needed in emerging disciplines such as information security and privacy.

Marketing

Technology has thrown a grenade onto the marketing landscape, and as a result, the skill set needed by today’s marketers is radically different from what was leveraged by the prior generation. Online channels have provided a way to track and monitor consumer activities, and firms are leveraging this insight to understand how to get the right product to the right customer, through the right channel, with the right message, at the right price, at the right time. The success or failure of a campaign can often be immediately assessed base on online activity such as Web site visit patterns and whether a campaign results in an online purchase.

The ability to track customers, analyze campaign results, and modify tactics has amped up the return on investment of marketing dollars, with firms increasingly shifting spending from tough-to-track media such as print, radio, and television to the Web.J. Pontin, “But Who’s Counting?” Technology Review, March/April 2009. And new channels continue to emerge. Firms as diverse as Southwest Airlines, Starbucks, UPS, and Zara have introduced apps for the iPhone and iPod touch. In less than four years, the iPhone has emerged as a channel capable of reaching over 75 million consumers, delivering location-based messages and services, and even allowing for cashless payment.

The rise of social media is also part of this blown-apart marketing landscape. Now all customers can leverage an enduring and permanent voice, capable of broadcasting word-of-mouth influence in ways that can benefit and harm a firm. Savvy firms are using social media to generate sales, improve their reputations, better serve customers, and innovate. Those who don’t understand this landscape risk being embarrassed, blindsided, and out of touch with their customers.

Search engine marketing (SEM), search engine optimization (SEO), customer relationship management (CRM), personalization systems, and a sensitivity to managing the delicate balance between gathering and leveraging data and respecting consumer privacy are all central components of the new marketing toolkit. And there’s no looking back—tech’s role in marketing will only grow in prominence.

Operations

A firm’s operations management function is focused on producing goods and services, and operations students usually get the point that tech is the key to their future. Quality programs, process redesign, supply chain management, factory automation, and service operations are all tech-centric. These points are underscored in this book as we introduce several examples of how firms have designed fundamentally different ways of conducting business (and even entirely different industries), where value and competitive advantage are created through technology-enabled operations.

Human Resources

Technology helps firms harness the untapped power of employees. Knowledge management systems are morphing into social media technologies—social networks, wikis, and Twitter-style messaging systems that can accelerate the ability of a firm to quickly organize and leverage teams of experts. Human resources (HR) directors are using technology for employee training, screening, and evaluation. The accessibility of end-user technology means that every employee can reach the public, creating an imperative for firms to set policy on issues such as firm representation and disclosure and to continually monitor and enforce policies as well as capture and push out best practices. The successful HR manager recognizes that technology continually changes an organization’s required skill sets, as well as employee expectations.

The hiring and retention practices of the prior generation are also in flux. Recruiting hasn’t just moved online; it’s now grounded in information systems that scour databases for specific skill sets, allowing recruiters to cast a wider talent net than ever before. Job seekers are writing résumés with keywords in mind, aware that the first cut is likely made by a database search program, not a human being. The rise of professional social networks also puts added pressure on employee satisfaction and retention. Prior HR managers fiercely guarded employee directories for fear that a headhunter or competitive firm might raid top talent. Now the equivalent of a corporate directory can be easily pulled up via LinkedIn, a service complete with discrete messaging capabilities that can allow competitors to rifle-scope target your firm’s best and brightest. Thanks to technology, the firm that can’t keep employees happy, engaged, and feeling valued has never been more vulnerable.

The Law

And for those looking for careers in corporate law, many of the hottest areas involve technology. Intellectual property, patents, piracy, and privacy are all areas where activity has escalated dramatically in recent years. The number of U.S. patent applications waiting approval has tripled in the past decade, while China saw a threefold increase in patent applications in just five years.J. Schmid and B. Poston, “Patent Backlog Clogs Recovery,” Milwaukee Journal Sentinel, August 15, 2009. Firms planning to leverage new inventions and business methods need legal teams with the skills to sleuth out whether a firm can legally do what it plans to. Others will need legal expertise to help them protect proprietary methods and content, as well as to help enforce claims in the home country and abroad.

Information Systems Careers

While the job market goes through ebbs and flows, recent surveys have shown there to be more IT openings than in any field except health care.2009 figures are from http://www.indeed.com. Money magazine ranked tech jobs as two of the top five “Best Jobs in America.”CNNMoney, “Best Jobs in America,” 2009, http://money.cnn.com/magazines/moneymag/bestjobs/2009/snapshots/1.html. BusinessWeek ranks consulting (which heavily hires tech grads) and technology as the second and third highest paying industries for recent college graduates.L. Gerdes, “The Best Places to Launch a Career,” BusinessWeek, September 15, 2008. Technology careers have actually ranked among the safest careers to have during the most recent downturn.T. Kaneshige, “Surprise! Tech Is a Safe Career Choice Today,” InfoWorld, February 4, 2009. And Fortune’s ranks of the “Best Companies to Work For” is full of technology firms and has been topped by a tech business for four years straight.See Fortune, “Best Companies to Work For,” 2007–2010. For 2010 list, see http://money.cnn.com/magazines/fortune/bestcompanies/2010/full_list/index.html.

Students studying technology can leverage skills in ways that range from the highly technical to those that emphasize a tech-centric use of other skills. Opportunities for programmers abound, particularly for those versed in new technologies, but there are also roles for experts in areas such as user-interface design (who work to make sure systems are easy to use), process design (who leverage technology to make firms more efficient), and strategy (who specialize in technology for competitive advantage). Nearly every large organization has its own information systems department. That group not only ensures that systems get built and keep running but also increasingly takes on strategic roles targeted at proposing solutions for how technology can give the firm a competitive edge. Career paths allow for developing expertise in a particular technology (e.g., business intelligence analyst, database administrator, social media manager), while project management careers leverage skills in taking projects from conception through deployment.

Even in consulting firms, careers range from hard-core programmers who “build stuff” to analysts who do no programming but might work identifying problems and developing a solutions blueprint that is then turned over to another team to code. Careers at tech giants like Apple, Google, and Microsoft don’t all involve coding end-user programs either. Each of these firms has their own client-facing staff that works with customers and partners to implement solutions. Field engineers at these firms may work as part of a sales team to show how a given company’s software and services can be used. These engineers often put together prototypes that are then turned over to a client’s in-house staff for further development. An Apple field engineer might show how a firm can leverage podcasting in its organization, while a Google field engineer can help a firm incorporate search, banner, and video ads into its online efforts. Careers that involve consulting and field engineering are often particularly attractive for those who enjoy working with an ever-changing list of clients and problems across various industries and in many different geographies.

Upper-level career opportunities are also increasingly diverse. Consultants can become partners who work with the most senior executives of client firms, helping identify opportunities for those organizations to become more effective. Within a firm, technology specialists can rise to be chief information officer or chief technology officer—positions focused on overseeing a firm’s information systems development and deployment. And many firms are developing so-called C-level specialties in emerging areas with a technology focus, such as chief information security officer (CISO), and chief privacy officer (CPO). Senior technology positions may also be a ticket to the chief executive’s suite. A recent Fortune article pointed out how the prominence of technology provides a training ground for executives to learn the breadth and depth of a firm’s operations and an understanding of the ways in which firms are vulnerable to attack and where it can leverage opportunities for growth.J. Fortt, “Tech Execs Get Sexy,” Fortune, February 12, 2009.

Your Future

With tech at the center of so much change, realize that you may very well be preparing for careers that don’t yet exist. But by studying the intersection of business and technology today, you develop a base to build upon and critical thinking skills that will help evaluate new, emerging technologies. Think you can afford to wait on tech study, then quickly get up to speed? Think about it. Whom do you expect to have an easier time adapting and leveraging a technology like social media—today’s college students who are immersed in technology or their parents who are embarrassingly dipping their toes into the waters of Facebook? Those who put off an understanding of technology risk being left in the dust.

Consider the nontechnologists who have tried to enter the technology space these past few years. Newscorp head Rupert Murdoch piloted his firm to the purchase of MySpace only to see this one-time leader lose share to rivals.O. Malik, “MySpace, R.I.P.,” GigaOM, February 10, 2010. Former Warner executive Terry Semel presided over Yahoo!’sJ. Thaw, “Yahoo’s Semel Resigns as Chief amid Google’s Gains,” Bloomberg, June 18, 2007. malaise as Google blasted past it. Barry Diller, the man widely credited with creating the Fox Network, led InterActive Corp (IAC) in the acquisition of a slew of tech firms ranging from Expedia to Ask.com, only to break the empire up as it foundered.G. Fabrikant and M. Helft, “Barry Diller Conquered. Now He Tries to Divide,” New York Times, March 16, 2008. And Time Warner head Jerry Levin presided over the acquisition of AOL, executing what many consider to be one of the most disastrous mergers in U.S. business history.J. Quinn, “Final Farewell to Worst Deal in History—AOL-Time Warner,” Telegraph (UK), November 21, 2009. Contrast these guys against the technology-centric successes of Mark Zuckerberg (Facebook), Steve Jobs (Apple), and Sergey Brin and Larry Page (Google).

While we’ll make it abundantly clear that a focus solely on technology is a recipe for disaster, a business perspective that lacks an appreciation for tech’s role is also likely to be doomed. At this point in history, technology and business are inexorably linked, and those not trained to evaluate and make decisions in this ever-shifting space risk irrelevance, marginalization, and failure.