Lecture Series: Creative Destruction: Business Survival Strategies in the Global Internet Economy

About the speaker: Lee McKnight is Associate Professor of International Communication and Director of the Edward R. Murrow Center at the Fletcher School of Law and Diplomacy at Tufts University, and a Visiting Scholar at MIT. He is co-author of The Gordian Knot: Political Gridlock on the Information Highway (1997), and co-editor of Creative Destruction: Business Survival Strategies in the Global Internet Economy (2001); Internet Telephony (2001); and Internet Economics (1997), all published by MIT Press. His peer-reviewed articles have appeared in journals such as Political Communication, Telecommunications Policy, INFO, IEEE Internet Computing, Communications & Strategies, Computer, Brazilian Electronic Journal of Economics, and Journal of Electronic Publishing. McKnight has been a Fellow of the Max Planck Foundation, the Friedrich Ebert Foundation, and the Volkswagen Foundation, among others. His current research focuses on the global Internet economy, international technology innovation policy, modeling the converging Internet and telecommunications industries, and Internet telephony policy.

Rapporteur's Report

On Thursday, April 19, 2001, the Project on the Information Revolution and World Politics hosted a lecture by Lee McKnight, entitled "Creative Destruction: Business Survival Strategies in the Global Internet Economy." The event coincided with the recent publication by MIT Press of a book by the same name, which McKnight co-edited with Paul Vaaler and Raul Katz.

McKnight began by noting that the recent fall of the Nasdaq and failure of many Internet firms has eliminated much of the heady optimism about the climate in which Internet businesses operate. Neither Internet firms nor the high-tech industry as a whole is immune to the dynamics that have shaped economic history for centuries. But recent economic trends should not suggest that the Internet presents nothing new to the business world, nor to governments that regulate that world through their policy choices. In light of the above, McKnight sought to describe the way in which the Internet has altered firms? economic environment, and what this new environment means for business survival strategies and government policy.

Citing the work of a number of political, economic, and business theorists, McKnight argued that the Internet creates a new media and economic environment, demanding new business strategies and policy choices. The advent of the Internet has blurred the lines between different media, he argued, but the Internet is also different enough from previous media that it cannot be effectively governed under traditional policy models. For instance, while the telephone facilitates one-to-one communication, and broadcasting follows a one-to-many model, the Internet is an any-to-any medium?it can take on both of the above functions, and also facilitate many-to-one or many-to-many communication. As the Internet increasingly subsumes the functions of other media, creating an effective policy environment for this new technology becomes an even greater necessity. Historically, all new media have generated opposition from entrenched interests, and the Internet is likely to be no different. But without regulatory reform to facilitate the growth of the Internet, politics as usual will stifle the emergence of new media and eventually all communications in society.

As was already noted, while the Internet economy has strong implications for business strategy, traditional economic dynamics still apply to firms doing business in the Internet environment. Contrary to the predictions of new-economy optimists, the Internet industry has not brought an end to the business cycle or created boundless opportunity for an unlimited number of new entrants. Companies will still have to compete, and those that emerge as successful will have to constantly respond to the changing conditions of their business environment. It is here that Joseph Schumpeter?s theory of creative destruction meets the Internet economy. In the Internet world, old businesses and industries will be destroyed even more rapidly, and firms must learn to identify, cope with, encourage, and exploit this dynamic. "For businesses, [creative destruction] is no joke," McKnight argued. "We can just read the daily business pages to see who?s dead, who?s dying, who?s merged? Their very survival is at stake. The only ones who may succeed are those who can be characterized as Internet agile."

McKnight went on the describe the specific characteristics of the Internet that drive creative destruction in the information age. The most important factor is the simplicity of the Internet itself?a feature that allows and encourages innovation at every level. "The key thing about the Internet is?that there is really nothing there at all?it?s just the Internet protocol," said McKnight. This protocol, governing the exchange of information between computers, is an open, non-proprietary base upon which other applications, services, and network technologies can be built. In each of these areas, the Internet facilitates innovation because of three characteristics: statistical sharing, network externalities, and interoperability. The first means that everyone?s data travels over the same path, a more cost-efficient method than telephone traffic, where a direct and exclusive link is established between two parties. The second means that the value of being connected to the network increases as more and more people are connected. The third means that the Internet bears a self-enforcing policy: to connect, new users must adhere to the underlying Internet protocol.

The technological architecture of the Internet and the innovation that it facilitates imply new rules for Internet firms. First, the Internet economy demands openness, interoperability, scalability, and extensibility. If a small company becomes suddenly popular, for instance, it must be able to deal with 100,000 people trying to reach its web page. Second, 24x7 commerce creates great potential, but it also generates 24x7 costs in the areas of security, privacy, and customer service. Third, the concept of "frictionless commerce" masks a great degree of aggressive competition between firms. "Everybody else could be aggregating information, trying to take away your business position," argued McKnight, "so you have to be thinking proactively too what you could be doing to be taking somebody else out in this new world of ?frictionless commerce.?"

To date, the record of success in the Internet economy has not matched the hype of the past several years; many firms have failed to make money in various areas of the industry. In e-commerce, neither vertical portals, nor business-to-business portals, nor business-to-consumer e-commerce superstores have in general proven to be profitable. The problem is that these retailers thought they would have a proprietary advantage, while most of the technology they use is standardized and non-proprietary. They should focus more on profitable retailing, argued McKnight, rather than supposedly proprietary features such as 1-click checkout. In the Internet access market, advertising-driven free access models have also not proven profitable, nor has the provision of high-speed services such as DSL and cable modems. Many expected that the Internet equipment market was the place to make money, but this too has changed as such firms as Lucent and Cisco encounter difficulties. Eventually, the dynamic of creative destruction will mean the end of many of these unprofitable firms, if it has not already.

McKnight emphasized, however, that there will definitely be survivors in this increasingly competitive environment, and that the Internet matters for the economy as a whole whether dot-coms are up or down. Those that survive will be the quickest to adapt to constant change?both the firms adapting to changing technology and market conditions, and the regions that adapt to changing infrastructural and educational needs. This dynamic is good news for global Internet businesses, argued McKnight, as it will accelerate the creative destruction of traditional computer, media, print, and telecom firms. Survivors will have to change their industry positions, adapt their organizational structures, and accelerate their technological cycles, but they will become stronger in the process.

The emerging Internet economy also holds implications for national and international policy makers, who must adapt their regulatory approaches to meet a new and ever-changing reality. "The same dynamics that businesses face, governments need to be thinking?through," he stressed. "The reality is the world?s changing around them whether they like it or not." Governments should bear in mind that the Internet means the real-time destruction of regulatory approaches, social assumptions, and international policy processes. The question is not whether new policy models are needed, but what type they should be. One could implement specific regulation for information and communication technologies, or broader regulation to cover all media. Even more sweepingly, one could treat information as just another product or service that can be bought or sold. McKnight argued for the second of these three options, stressing that the Internet can assume the form of other media, but that media still merit special attention within the economy as a whole.

Following McKnight?s presentation, several members of the audience posed questions for him to consider. Project director William Drake began by noting that governments in the United States, Europe, and Japan have pursued markedly different technology policies to support Internet businesses in their countries. In light of the rapid technological changes and industry churn in the Internet environment, he asked, which of these strategies have proven viable, and which have not? McKnight replied that governments must be flexible in their approaches to solving both new and old problems, and that they should consider public-private partnerships, outsourcing some of their functions to the private sector. Additionally, governments must design regulatory structures that adequately address new technologies and applications (such as Internet broadcasting), rather than squeezing them into old regulatory models or letting them fall through the cracks.

Other questions addressed a variety of issues, from the Internet in the developing world to the national security implications of changing technologies. One audience member noted that developing countries can leapfrog over stages of technological development, moving directly to advanced technologies like wireless phone systems without modifying existing infrastructure. Will creative destruction be easier in these countries, he asked, since nothing needs to be destroyed? McKnight responded that it would, but that governments in those countries would still need to adapt new policy frameworks to adequately address changing technology. Another noted the recent energy crisis in California, asking whether we have sufficiently examined the interrelation between electricity (or petroleum) and the Internet economy. McKnight replied that we currently see an imbalance in California, but with energy companies like Enron moving into the Internet economy, the future may look brighter.

A third audience member asked about the impact of the Internet on education. In response, McKnight stressed that literacy is becoming increasingly important for a country?s success in the information economy, both in developing countries and in the U.S. as well. He also noted that technology is changing higher education, with the availability of distance learning and online degree programs. Finally, one attendee asked about the security of critical infrastructures as everything migrates to the Internet. McKnight responded that this was indeed an important issue for the United States, but that it was much more of a problem for the rest of the world. No other country has comparable monitoring schemes or rapid response teams, he noted. Likewise, the United States? capacity for offensive information warfare is likely to outweigh any particular vulnerability that it faces.

Report prepared by Taylor Boas.