That you haven't done to me already?
--Willie Nelson, What Can You Do To Me Now?
There is little doubt about the Internet's effect on competition. In market after market, online prices are falling and companies are experimenting with business models that have lower, if not negative, gross margins. In addition to affecting the absolute intensity of competition, the Internet is also having a fundamental effect on the structure of competition.Microeconomics 101 falls far short of giving you the tools you need to succeed in a Web-based world. There are many, many new rules, and those players using yesterday's playbook are in for a rather rude awakening.
The least obvious, but most interesting, way the Internet is changing competition is through the blurring of the boundaries that have historically existed between markets. Imagine if you will a large body of land covered by independent lakes. Think of these lakes as markets, and the species that live in each lake as competitors. Over time, these individual ecosystems have evolved separately, and certain species have emerged as leaders in each market (lake). Now imagine what would happen if a canal were installed between each and every lake, thereby enabling each species to swim freely among them. This is the effect the Internet, as an electronic version of the canal, is having on business. Your competition is no longer limited to your lake, and you may find yourself face to face with a species you have never seen before.
Consider Amazon.com. As the leading online bookstore, Amazon certainly competes with Barnes and Noble, the world's largest "brick and mortar" bookstore. However, many in Silicon Valley think Amazon's true longer-term competitor is Yahoo. Amazon is expanding into new product categories like CDs, videos, and gifts and is incorporating the technology it acquired when it bought Junglee, a startup whose software efficiently searches the Web, to make comparison shopping easy for consumers.. This seems to put Amazon on a collision course with Yahoo's "Yahoo Store" initiative, which also lets Web surfers comparison shop and order products. One could also argue that Amazon.com competes with the New York Times as a content resource that book readers use to help them identify their next interesting book choice. It is noteworthy that the New York Times broke the story about Amazon accepting marketing dollars from publishers, given that they are, in fact, in direct competition for those same marketing dollars. But why stop there? Some people would argue that Amazon is evolving into an online transaction company, which could mean that they would eventually compete with financial institutions such as credit card companies.
This phenomenon is not just limited to Amazon. As more companies begin to develop their Web strategies, they are finding themselves faced with competitive questions that they have never considered. Is Office Depot in competition with Staples, or should it be more concerned with the rise of automated purchasing applications? These apps put more power in the hands of the buyer, potentially remove the ability of the retailer to differentiate, and can grease the skids for a direct connection between the buyer and the manufacturer. The important thing to note is that the distance along the supply chain, both vertically and horizontally, will be driven to zero by the Internet. Everyone is a potential competitor, and it will become increasingly difficult to determine where your product or service ends, and someone else's begins.
The Internet is also having a dramatic effect on the distance between the market leader, the second place contender, and everyone else. Morgan Stanley's Internet analyst, Mary Meeker, likes to say that on the Web being No. 1 is awesome, No. 2 is OK, No. 3 is tough, No. 4 is the pits, and No. 5: "Huh? Who?". This may be an understatement. Increasing returns, positive feedback loops, and lock-ins abound in Internet-based businesses, and the potential non-standard economies of scale are intense. While most of the Internet digerati have already bought into this concept, some people still make the following two observations. First, the doubters say that the online leaders should be concerned because yesterday's leaders are now focusing on the Net. Others say that because certain markets are large there will be room for multiple players. Wrong and wrong.
The single best description of the phenomenon of increasing returns can be found in Brian Arthur's July 1996 article in the Harvard Business Review, entitled "Increasing Returns and the New World of Business." The simple take is that as an online leader grows, further growth becomes easier, not harder--a concept that is foreign to most traditional business, which suffer from dis-economies of scale. Consider the limitations of geography in a physical business. As retailers expand, they must build retail storefronts and distribution infrastructure. In addition, they are typically settling for smaller and smaller markets, having hit the largest ones first. The online player, however, has instant reach--the cost of acquiring a customer in Cleveland is the same as finding that person in Fargo, North Dakota.