Impact of the Internet on Intermediaries
By
Anurag Mehra
M.B.A (1990), University of Delhi
B.Tech. (1988), Indian Institute of Technology, Delhi
SUBMITTED TO THE DEPARTMENT OF CIVIL & ENVIRONMENTAL
ENGINEERING (CENTER FOR TRANSPORTATION STUDIES)
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF
MASTER OF ENGINEERING IN LOGISTICS
at the
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
June 1999
@ 1999 Anurag Mehra, All Rights Reserved
The author hereby grants to MIT permission to reproduce and distribute publicly paper
and electronic copies of this thesis document in whole or in part
Signature of the Author .......................
Uv.................................................
Depa ment of Civil & Environmental Engineering
Center for Transportation Studies
May 7, 1999
C ertified by .......................................
....... . .
.................................
Yossi Sheffi
Director, MIT enter for Transportation Studies
Thesis Supervisor
Accepted by .....................................
Whittle
Chair, Departmental Committee on Graduate Studies
MASSACHUS
Impact of the Internet on Intermediaries
by
Anurag Mehra
Submitted to the Department of Civil & Environmental Engineering
In partial fulfillment of the requirements for the Degree of
Master of Engineering in Logistics
Abstract
The exponential growth of the Internet has led to the growing debate about
"disintermediation, i.e. the elimination of intermediaries from markets. Many believe that
traditional intermediaries will soon become extinct because the Internet allows producers
to sell directly to consumers in a more cost-effective way. The debate on
disintermediation in the literature has so far focussed only on "elimination" of
intermediaries, which assumes that all the functions performed by intermediaries can be
disintermediated by the Internet. A deeper analysis of the raison d'etre of intermediaries
suggests that "elimination" of intermediaries is an extremely unlikely scenario. Broadly
speaking, intermediaries perform three functions in a marketing channel: information &
transaction function, logistics function and trust function. Clearly, the Internet can impact
only the information and transaction function, while the logistics and trust issues still
need to be addressed.
This thesis explores the issue of disintermediation from a different perspective: how the
Internet will lead to reorganization of intermediary functions and what kind of
disintermediation scenarios may emerge. It assumes that the allocation of different
functions among various entities in a channel (manufacturers, intermediaries and
consumers) will depend on who can perform the function more efficiently in the long run.
Based on this premise, the thesis explores various disintermediation scenarios and their
applicability to different industries in relation to the consumer needs and buying
behavior.
The thesis develops a framework in terms of a decision flowchart that can be used to
evaluate the possibility of different disintermediation scenarios for specific products/
industries. The framework fulfills the twin objectives of integrating the different
approaches on distribution channels found in the literature and providing a starting point
for further research on industry-wise impact of the Internet on channel structure.
Thesis supervisor: Yossi Sheffi
Title: Director, MIT Center for Transportation Studies
3
To my parents,
my wife Ekta and our newly born son Anirudh
4
Acknowledgements
I would like to thank Prof. Yossi Sheffi for his guidance, encouragement and thoughtful
criticism during the entire duration of my thesis work. Our 'weekly meetings', without
which it may have been impossible to finish this thesis in this short duration of time,
tremendously helped me in focussing on the key issues of this thesis. I am also grateful to
Mr. Jonathan Byrnes for his constructive feedback on the first draft of this thesis.
5
Table of Contents
1
IN TR O D U C TION :...............................................................................................................................
2
CON TEX T A N D LITERA TU RE R EV IEW :...................................................................................
6
11
.......
11
2.1
COST OF INTERM EDIATION:..........................................................................................
2.2
D IRECT CHANNELS: .......................................................................................................................
12
2.3
INDIRECT CHANNELS: ............................................................................-.......................................
15
2.3.1
Role of intermediaries: .......................................................................................................
15
2.3.2
Channel Structure:...................................................................................
...... 17
................
IM PACT OF THE INTERNET: .........................................................................................................
27
3
RESEA R CH HY PO TH ESIS:............................................................................................................
32
4
RESTRUCTURING OF INTERMEDIARY FUNCTIONS: ..........................................................
36
2.4
5
6
INFORM ATION INTERM EDIARIES ...................................................................................
4.2
LOGISTICS INTERMEDIARIES .........................................................................................
. .........
39
4.3
V ALUE-ADDED INTERMEDIARIES .................................................................................
..........
40
DEVELOPING AN INTEGRATED FRAMEWORK: ...................................................................
42
5.1
KEY FACTORS AFFECTING DISTRIBUTION CHANNEL STRUCTURE ...................................................
43
5.2
IMPACT OF THE INTERNET & 3PL SERVICES: .................................................................................
48
5.3
CONSUMER BUYING BEHAVIOR ...................................................................................................
50
5.4
D ECISION FLOW CHART ...........................................................................-
-....... ---.--........
--....... 54
EX PLO RA TO RY A N A LY SIS:.....................................................................................................
59
6.1
(D IS)INTERM EDIATION SCENARIOS: ............................................................................................
59
6.2
CASE STUDIES:..........................................................................................--.-.............................
75
6.2.1
Books: ...................................................................................................................................
75
6.2.2
Computers:............................................................................................................................
79
6.3
LIM ITATIONS OF EXPLORATORY ANALYSIS:...................................................................................
CON C LU SIO N :..................................................................................................................................
7
8
36
4.1
.-.......
-... ---...................................
7.1
THESIS FINDINGS: .............................................................-
7.2
FUTURE RESEARCH: .....................................................................................
REFER EN C ES:.................................................................................................-----......-
--.
-.. --......................
84
85
85
86
88
--. . --............
6
1 Introduction:
Rapid technological progress in information and communication technologies along with
their widespread diffusion have led to speculation about "frictionless" economies in
which transaction costs are nearly zero, barriers to entry disappear, and markets clear
instantly. Some think that electronic commerce, with producers selling directly to
consumers over computer networks such as the Internet, will eliminate existing
intermediaries ("disintermediation") and drastically reduce transaction costs (OECD,
1998).
Transaction costs:
The work done by Ronald H. Coase in introducing the concept of transaction costs in
understanding why firms exist in the form and size that they are, is perhaps more relevant
now than ever. In his article "The Nature of the Firm" (published in 1937, for which he
received the Nobel Prize in Economics in 1991), he addressed the following basic
question (Coase, 1992):
"Why do firms exist, if the pricing mechanism (Adam Smith's 'invisible hand') can
do all the coordination necessary for markets to work?"
Coase found that the answer lies in transaction costs. He realized that there were costs
involved in using the price mechanism: costs related to negotiations, contracts,
inspections, dispute settlements etc. It was the avoidance of the costs of carrying out
transactions through the market that could explain the existence of firms in which
allocation of factors came about by administrative decisions rather than price mechanism.
Hence, Coase argued that a firm would grow in size up to a point when the cost of
internal coordination exceeds the cost of market transactions. Similarly, a firm would
outsource an activity or a function if the transaction cost were lower than internal
coordination cost.
7
The role of intermediaries in a market can be explained in terms of reduction in
transaction costs. For a firm trying to sell directly to its customers, the cost of
communication, distribution and servicing may be quite large if the customers are
geographically spread out and buy in small quantities. Intermediaries reduce this cost by
providing aggregation and dis-aggregation services. The explosive growth of the Internet
has now provided manufacturers/ sellers a low cost access to consumers. So the following
question arises:
"Why should intermediaries exist, when the Internet allows
(by reducing
transaction costs) sellers and buyers to transact directly through the pricing
mechanism?
The growing phenomenon of online auctions is evidence of the disintermediation
possibility. So is the online success of organizations like Amazon.com and Dell. A
potentially larger impact involves the displacement of intermediaries whose basic
function is to convey information that is asymmetrically possessed, for example by travel
agents, insurance agents, stockbrokers, real estate agents, etc. There is evidence of
decline in commissions of stock traders by as much as 57% and of travel agents by 43%
(OECD, 1998). Similarly, for products that can be digitized (e.g. software, music &
video), traditional intermediaries will face much greater prospects of disintermediation
than other industries. For instance, software distributor Egghead (www.egghead.com)
closed over eighty traditional outlets to become the first retailer to make the transition to
Internet-only retail model (BusinessWire, 1998).
However, there is evidence to the contrary too. Bailey and Bakos (1997) explored
thirteen case studies of firms participating in electronic commerce and found that new
roles arise for electronic intermediaries that seem to outweigh any trends toward
disintermediation. A quick look at the top ten shopping sites on the Internet gives some
interesting insight. According to Media Metrix (www.mediametrix.com), an Internet and
8
Digital Media measurement company, the top ten shopping sites (as of Feb, 1999) with
visitors ranging from 2-12 million per month are:
1. www.bluemountainarts.com
2. www.aol.com
3. www.amazon.com
4. www.eBay.com
5. www.cnet.com
6. www.barnesandnoble.com
7. www.cdnow.com
8. www.columbiahouse.com
9. www.musicblvd.com
10. www.valupage.com
Interestingly, none of these sites belong to a manufacturer. Amazon.com's success is
often quoted as evidence of the growing disintermediation phenomenon. However, the
reality is just the opposite. Amazon.com is just another intermediary, albeit not of the
traditional kind. This confusion arises because people generally fail to make a distinction
between the following two questions:
1. Is a product suitablefor online sales (i.e. will the consumers buy over the Net)?
2. Is a product suitablefor direct (manufacturerto consumer) online sales?
Clearly, books are very well suited for online sales, but it does not imply that publishers
will start selling directly to consumers. In the case of Amazon, it is like a wholesaler
selling directly to the consumers on the Net, and therefore disintermediating the retailers.
Research areas:
Since electronic commerce is still at a very early stage in its development, much of the
thinking in this area is based on speculation or anecdotal evidence. As with the advent of
9
any new technology that may be widely diffused, there are overly optimistic and
pessimistic predictions, which are generally inaccurate (mail order has not displaced
traditional retail trade and the VCR has not displaced teachers). To correctly understand
the impact of electronic commerce on markets and economies, research is required in
every aspect of e-commerce. Some of the research areas identified by OECD (1998) are:
1. A statistical methodology and apparatus for measuring electronic commerce should
be developed.
2. The economy-wide and sector-specific impact of e-commerce on productivity should
be assessed, and the notion that this application may lead to a sustained higher level
of economic efficiency should be explored.
3. Monitoring of the restructuring of intermediary functions is needed.
4. Sectoral studies on a variety of consumer and business products should be undertaken
to measure the impact and identify factors that encourage and inhibit price
competition, including the use of intelligent agents. The impact of the structure of
price setting and of the frequency of price changes on markets and on measurement
also requires study.
5. The electronic marketplace needs to be continuously monitored. Case studies should
address the sectoral and market specificity of organizational impacts. Ongoing
assessment of potential new barriers to market entry is also needed.
Focus of the thesis:
This thesis addresses the third issue identified above, i.e. the impact of electronic
commerce on the structure and form of intermediaries and analysis of sectoral differences
in "disintermediation".
10
In order to assess the impact of Internet on intermediaries in a specific industry, it is
important to analyze the following:
1. From manufacturer's perspective, the cost tradeoffs involved in going direct vs. going
via intermediaries.
2. The raison d'8tre of intermediaries in that industry, i.e. what economic value is added
by the intermediaries. Value addition may be in non-monetary forms like riskmitigation.
3. Consumer needs, expectations and buying behavior.
This research being exploratory in nature, does not go into industry-specific cost
structures. The other issues related to the role of intermediaries and the relevance of
consumer buying behavior to channel structure are discussed in greater detail.
Specifically, this research aims to answer the following questions:
1)
What are the product/ market characteristics and other variables that have an
impact on the structure of distribution channels and existence of intermediaries?
2)
What is the impact of the Internet on these variables and therefore on channel
structure for different industries?
3)
If disintermediation is a possibility, what kind of disintermediation may occur?
Will wholesalers be impacted more or retailers? Will traditional intermediaries
transform into cyber-intermediaries?
11
2 Context and Literature Review:
This chapter examines the role of intermediaries and their raison d'etre in distribution
channels. Section 2.1 describes the cost added by intermediaries to explain why
disintermediation is such a big issue in e-commerce. Section 2.2 examines why direct
search markets have remained a small niche so far and how the Internet is changing the
tradeoffs in direct vs. intermediated markets. Section 2.3 describes the role of
intermediaries and various theories of distribution channel structure found in the
literature. Section 2.4 examines the disruptive power of the Internet and why it may lead
to disintermediation.
2.1 Cost of intermediation:
In the chain of activity between the final producer and the final consumer, intermediaries
generally perform three services - transportation, wholesaling, and retailing. In most
OECD countries, intermediaries typically add about 33 per cent to the final price of
goods. In the United States, for all personal consumer expenditures (PCE) (goods and
services), intermediaries add about 15.6 percent to the final price, of which 0.6 per cent
represents transportation, 3.8 percent wholesale costs, and 11.2 percent retail costs
(OECD, 1998). In some cases, the cost added by intermediaries may be as high as 62% as
illustrated for high-quality shirts market (Benjamin and Wigand, 1995):
12
A. Thie Variants of Altemate Value Added :i1aum
Cost per
Percent
Retailer
Consumer*
$52.72
0%
Wholesaler
Retailer
Consumer*
$41.34
28%
Wholesaler
Retailer
Consumer*
$20.45
62%
1.
Producer
Wholesaler
2.
Producer
3.
Producer
----
>
B. Growth in Value Added ard Selling Price
Producer
Wholesaler
Retailer
Value Added
$20.45
$11.36
$20,91
Selling Price
$20.45
$31.81
$52.72
Consumer*
$52.72
* Consumer transaction costs are not consid ered.
The above example illustrates how disintermediation (of retailer, wholesaler or any other
intermediary between the producer and the consumer) can save substantial costs for
manufacturers and (ultimately) consumers. It is not surprising therefore that some forms
of direct channels exist in the economy.
2.2 Direct channels:
Not all markets require intermediaries to function. Garbade (1982) classifies marketbased coordination into four categories:
1. Direct-search markets (where buyers and sellers seek out one another).
2. Brokered markets (where brokers assume the search function).
3. Dealer markets (where dealers hold inventory against which they buy or sell).
4. Auction markets (where buyers and sellers meet to bid for goods on sale).
Except for the first category of markets, all other types of markets depend on
intermediaries to facilitate market transactions. Direct search markets have traditionally
been limited in their appeal due to the high cost of searching buyers or sellers, even
though there may be some savings in distribution costs. Generally, there is a tradeoff
13
between high search costs of direct channel and high distribution costs of indirect
channel:
Direct channel
High search
costs
Indirect channel
High distribution
costs
Data from the 1992 Census of Retail Trade shows that non-store retailers (SIC code 596)
accounted for 51 billion dollar of sales, which is only about 2.7% of the total retail sales
($1.9 trillion). Out of this, catalog and mail-order houses accounted for 34 billion dollars
of sales. According to the Direct Marketing Association (www.the-dma.org), consumer
catalogue sales in 1998 was about $53 billion (out of total catalog sales of about $87
billion, and total retail sales of $2.7 trillion), generated by an estimated 12 billion
catalogues mailed to consumers, at a cost of about 70 cents each (New York Times,
1998). With such high costs, it is not surprising that catalog marketing has remained a
small segment of total retail market. However, this picture is now dramatically changing
because the marginal cost of reaching customers directly on the Internet is negligible
compared to the mail-order catalog:
Internet
Direct channel
High search
costs
Indirect channel
High distribution
costs
The Internet, as a direct marketing channel not only has many similarities with mail-order
catalog business but also has the potential to combine the best of catalog and TV-based
shopping, while adding unique advantages like interactivity (Goldman Sachs, 1997).
14
Companies can, in fact, do things with web that may have been impossible in catalogues
due
to
production
costs
and
space
limitations.
For
example,
Crutchfield
(www.crutchfield.com) has a vehicle selection chart where shoppers type the year, make,
model, and body type of their vehicle into the interactive Vehicle Selector, and the site
automatically customizes all subsequent pages to feature only components that will work
in that car. The Internet also allows catalogers to tailor pricing on a daily basis in
response to consumer demand, making them less vulnerable to excess inventory and
markdown concerns. Hence, the Internet has taken catalog business to a much higher
level of sophistication that can be exploited by savvy marketers to increase their revenues
and profitability. The importance of catalog sales in retailers e-commerce strategy is
evident in the tender offer (source: Bear Stearns Equity Research, 1998) made by
Federated Department Stores (owners of brand names like Macy's and Bloomingdale's)
for 100% of Fingerhut (2 "dlargest cataloger in U.S.) shares for a deal valued at $1.7
billion.
W.A.Dean & Associates, a catalogue industry consulting company estimates that more
than half of the consumer cataloguers currently have e-commerce sites (New York times,
1998). Catalog Age (www.catalogagemag.com) ranking of the top 100 US catalog
companies also gives an indication of how these two businesses are merging. The
revenue of 10 computer-only catalogers ($27 billion) accounts for more than 45% of total
catalog sales ($60 billion) in 1997. Leading the pack in computer-only catalogers are of
course Dell ($11.9 billion) and Gateway ($6.3 billion), who earn a substantial portion of
their revenues through Internet sales.
So it appears that the Internet holds a lot of promise for direct marketers like catalogers,
but its impact on traditional channels of distribution is not so clear. As discussed earlier,
there is mixed evidence of disintermediation and reintermediation, depending on the
changing role of the intermediaries.
15
2.3 Indirect channels:
2.3.1
Role of intermediaries:
Several roles of intermediaries have been identified in the literature. Malone, Yates and
Benjamin (1989) identify the following reasons for existence of intermediaries:
1. Aggregate buyers' demand or sellers' products.
2. Build trust between buyers and sellers.
3. Facilitate the market by reducing transaction costs.
4. Match buyers and sellers.
All the functions mentioned above have one common objective: improving the efficiency
and efficacy of the channel. Sarkar, Butler & Steinfield (1998) suggest a broader list of
functions performed by intermediaries, dividing them into two categories:
1. Services to consumers:
Search and Evaluation. Retail intermediaries design the type of the search and
evaluation services that will be offered to consumers by choosing the product mix and
focus. A consumer choosing a specialty store over a department store implicitly chooses
between two alternative search and evaluation criteria.
Needs Assessment and Product Matching. In many cases it is not reasonable to assume
that individual consumers possess the knowledge needed to assess their needs reliably
and identify the products which will efficiently meet those needs. Therefore,
intermediaries can provide a valuable service by helping customers determine their needs.
16
Customer Risk Management. Consumers do not always have perfect information, and
hence they may purchase products that do not meet their needs. Consequently, in any
retail transaction the consumer faces a certain amount of risk. By providing consumers
with the option to return faulty products
or providing
additional warranties,
intermediaries reduce the consumers' exposure to the risk associated with producer or
communication error.
Product Distribution. Many intermediaries play an important role in the production,
packaging, and distribution of goods. Distribution service firms, such as Federal Express,
are a prime example of how information technology has begun to make it economical to
independently provide services that historically have been provided by integrated retail
intermediaries.
2. Services to producers:
In addition to providing services for consumers, intermediaries also provide a variety of
services for producers. In choosing marketing channels, producers choose the bundle of
services provided by the intermediaries involved. Several functions of intermediaries
purchased by producers are briefly highlighted below.
Product Information Dissemination. Intermediaries provide service to producers by
informing consumers about the existence and characteristics of products. In some cases,
such as traditional retail intermediaries, these information services are tightly tied to other
services, such as distribution, and in other cases the information services and distribution
may be provided by independent intermediaries.
Purchase Influence. Ultimately producers are not interested only in providing
information for consumers; they are interested in selling products. Thus, in addition to
information services, producers also value services related to influencing consumer
purchase choices. Intermediaries can influence consumers' purchasing behavior by
strategic product placement, explicit advice from sales agents etc.
17
Provision of Customer Information. Intermediaries also provide valuable information
about customers to producers, that is used by producers to evaluate new products and
plan production of existing products.
Producer Risk Management. Like consumers, producers face risks when engaging in
commercial transactions. Intermediaries provide services that enable producers to manage
their exposure to such risks as inventory risks, consumer fraud and risk associated with
consumer and producer error.
Transaction Economies of Scale. As with production of goods, transaction services (e.g.
order aggregation) provided by intermediaries are subject to economies of scale, which
are often achieved through the use of IT. Also economies of scale in transportation allow
intermediaries to reduce the total cost of distribution for the channel.
Integration of Consumer and Producer Needs. Intermediaries must deal with problems
that arise when consumer needs conflict with the needs of producers. In a competitive
environment an intermediary must provide a bundle of services that balances the needs of
consumers and producers and is acceptable to both. For example, a producer may wish to
inform consumers about the existence of a good while consumers may not wish to receive
it & would rather have it filtered out as part of the product search and evaluation process.
2.3.2 Channel Structure:
A channel of distribution can be considered to comprise a set of institutions which
performs all the activities (or functions) utilized to move a product and its title from
production to consumption (Bucklin, 1966). A typical distribution channel may look like
the following:
Manufacturer
Intermediary 1
Intermediary2
Consumer
18
Where, intermediaryl may be a wholesaler/ distributor and intermediary2 may be a
retailer. Hence, a channel may be defined in terms of the following three variables related
to the intermediaries:
1. Levels of intermediaries (number of echelons in the channel).
2. Number of intermediaries in each level.
3. Exclusivity of intermediaries (eg. geographic coverage).
A normative channel is generally defined in the literature as a set of institutions which, in
the long run, and under conditions of competition and low barriers to entry, constitutes
the channel for a product. The purpose of defining such a channel is to understand the
basic forces that control channel structure and to develop a benchmark against which real
world channel structures may be meaningfully compared.
The real world channel may be different from the normative channel because of two
reasons. First, many barriers prevent the realization of the full effect of competitive
forces, and second, the normative channel is a long run concept- an equilibrium that may
never be realized because of continuous technological and social changes. The Internet
has, in no small measure, contributed to the dizzying pace of change that firms face
today. Hence, in today's environment, the concept of normative channels may be a purely
theoretical construct, but still worthy of study for the insights it can provide on what the
future may hold for distribution channels.
Most of the marketing literature on distribution channels focuses on normative channels.
Four different approaches have appeared in the literature in development of theory of
distribution channel structure (Frazier, 1987):
1. Bucklin (1966): theory of distribution channel structure.
2. Mallen (1973): functional spin-off approach.
3. Williamson (1979): transaction cost approach.
4. Anderson & Weitz (1983): scale economies approach.
19
Bucklin (1966) relates the structure of distribution channels with the functions performed
by all the organization entities involved in the channel flows, including the consumer. He
identifies five categories of activities/ functions:
1. Communication function: consisting of all activities that serve to transmit to
prospective buyers or sellers information concerning offers to buy or sell and the
acceptance of these offers.
2. Ownership function: concerned with activities that surround the holding of title to
goods.
3. Inventory function: includes all activities that physically control the product at a
given location, not including the capital or risk charges incurred by storage, that being
part of the ownership function.
4. Transit function: includes all activities that physically transport goods between
locations.
5. Production function: consists of all activities that create the product or commodity.
The way Bucklin relates these functions to the channel structure is as follows:
Consumer
Demand for
channel outputs
Channel
Outputs
Functional
structure
Channel
structure
The channel outputs are defined in terms of three variables:
1) market concentration
2) delivery time
3) Lot size
Market concentration concerns the size distribution of customers a firm faces as well as
their geographic density. The more concentrated a market, the more feasible is a "direct"
channel because costs of serving such a market would be lower by direct or shorter
20
channel. Similarly, the more customer service required by the customers (in terms of
faster delivery times and smaller lot sizes), the less desirable is a "direct" channel.
Direct channel
Indirect channel
Cost
Services
Direct
Indirect
The cost of providing increasing level of services to consumers generally increases more
rapidly for direct channels than for indirect channels. On the other hand, at low level of
service, indirect channels are likely to be costlier than direct channels because of the
fixed costs associated with the intermediary functions. Hence, there generally exists a
breakeven point below which direct channels are more efficient and above which indirect
channels.
So the basic construct of Bucklin's theory of distribution channel structure is that
consumers determine the desired channel output, which in turn determines the division of
functions among various organizational entities (including the consumer) and therefore
eventually the channel structure based on the long-run efficiency of different channel
types. Alderson (1957) supports this argument by contending that the efficiency of
vertical market structures is improved by the performance of two functions by
intermediaries: matching and sorting.
Based on the above theory, Bucklin, Ramaswamy & Majumdar (1996) propose the
following hypotheses:
21
1. In markets where end-users buy in small quantities, indirect channels are more likely
to prevail.
2. In markets where goods must travel great distances to reach the end-user, indirect
channels are more likely to prevail.
3.
Under market conditions characterized by end-users who purchase frequently,
indirect channels are more likely to prevail.
4. Under market conditions characterized by manufacturers who produce narrow
assortments, indirect channels are more likely to prevail.
5. In markets where product customization is critical to end users, direct channel
structures are more likely to prevail.
6. In markets characterizedby intense product or technological activity, direct channels
are more likely to prevail.
7. In markets characterized by rapid technological change, direct channels are more
likely to prevail.
8. In markets characterizedby higher customer concentration, direct channels are more
likely to prevail.
It is interesting to note the relevance of hypothesis no. 6-8 to the computer industry and
how these have been successfully leveraged by Dell (www.dell.com) for its direct model.
A more detailed discussion of Dell's model is covered in Section 6.2.
Bucklin also developed a framework in which the generic classification of goods given
by Copeland (1923) is related to the distribution channel structure (Bucklin, 1963). It
suggests that for convenience goods (e.g. groceries), an indirect channel is more suited,
while for shopping goods (e.g. consumer electronics), a direct channel may be more
desirable. This conclusion can be derived from the theory described above, since for
shopping goods, consumers are probably willing to wait to get exactly what they want,
while for convenience goods, consumers require higher service (faster gratification) and
are therefore better off picking the goods from the nearest retail outlet rather than wait.
22
Catalog marketers have traditionally used this classification to sell goods that consumers
want and are willing to wait for. The only problem with catalog marketing has been the
fact that the communication between the sellers and the buyers is essentially a one-way
process, i.e. from the sellers to the buyers. Although catalog sellers rely on extensive
market research to determine the type of goods desired by the consumers, and consumers
also have a choice of selection and ordering, broadly speaking catalog marketing has
remained a uni-directional marketing process. However with the ubiquity of the Tnternet,
this is bound to change. Consumers can now be expected to have a greater say in the
selling process in terms of determining the goods they want in the first place. In
electronic marketplaces, intermediaries such as www.priceline.com allow buyers to
specify product and price requirements and make corresponding offers to participating
sellers, reversing the traditional transactional flow of retail/ catalog markets.
Bruce Mallen's (1973) approach is based on the assumption that functions (e.g. delivery,
warehousing, selling) will align in the channel based on who (manufacturer, wholesaler,
retailer etc.) can do them most efficiently. For example, if a manufacturer finds that the
stocking function can be done at much lower cost by a retailer, it will spin-off the
function to an independent retailer.
Williamson (1979) developed what is commonly referred to as the "transaction cost
analysis" approach. It is the application of the work done by Ronald H. Coase on
transaction costs to the institutional framework of distribution channels. According to this
approach, firms and consumers try to reduce their transaction costs as much as possible.
In this process, intermediaries will be created if there is an opportunity to reduce the
transaction costs between sellers and buyers. A key concept in this approach is "asset
specificity" which refers to the uniqueness of the assets needed to facilitate product and
title flows in the channel. To keep transaction costs low, firms would be better off going
direct if the asset specificity were high, especially when high uncertainty exists in the
environment. Indirect channels with high asset specificity under conditions of high
uncertainty will have high transaction costs, in part because of possible opportunistic
23
behavior of the channel members in possession of the specific assets, and in part because
contingent contract are difficult to develop under conditions of high uncertainty.
Transaction cost theory is an often-employed framework in the context of channel
structure since it focuses on a firm's choice between internalized, vertically integrated
structures, and the use of external market agents for carrying out activities that constitute
its value chain. In the context of channel decisions, it can be used to articulate the
decision process whereby firms either "make or buy" an intermediary function; that is,
whether the firm decides to internalize the channel activity (or sub-activities) within its
organizational boundaries, or whether it chooses to rely on the market.
A fourth approach, developed by Anderson and Weitz (1983) and generally referred to as
"scale economies" approach, predicts that small manufacturers with limited product line
are better off using indirect channels since independent intermediaries can accumulate the
products of other manufacturers and therefore incur lower selling costs. Internet has,
however, drastically changed the rules of the game for small players. Small
manufacturers are no longer inhibited by geographical constraints and potentially have
access to the entire global market (subject to the reach of the Internet).
Not much effort has been made in the past to integrate these different approaches or to
develop a common framework. Frazier (1987) while identifying this as an important
research need, integrates the framework of Bucklin (1966) and Williamson (1979) as
follows:
Asset specificity = Low
Low M.C
High CSR
Low M.C
Asset specificity = High
Low capital
availability
Indirect
High capital
availability
Indirect
Low capital
availability
Indirect
High capital
availability
Combo
Indirect
Combo
Combo
Direct
Indirect
Direct
Combo
Direct
Combo
Direct
Combo
Direct
Low CSR
High M.C
High CSR
High M.C
Low CSR
24
Where, M.C = Market concentration, CSR = Customer service requirements, Combo =
Mix of direct and indirect channels.
The above table highlights the importance of integrating these different approaches. For
instance, it shows that high asset specificity does not always imply direct channels,
especially if market concentration is low and service requirements of customers are high.
Similarly, high market concentration or low service requirements alone are not sufficient
conditions for direct channels.
Besides these four qualitative frameworks, there have been some attempts do develop
quantitative models of distribution channels. Balderston (1958) explains the existence of
intermediaries by a single variable: contact and communication costs. He contends that
every intermediary that cooperates but does not compete, reduces by its presence the total
cost of contact and communication in the system. For instance, if m = number of
producing firms, n = number of buyers and r = number of intermediaries (say retailers),
the number of contacts made in a direct channel will be = m x n; while in an indirect
channel it will be = r (m + n). Intermediaries will be drawn into the system (i.e. r will
increase) so long as the total contact and communication cost in the channel reduces,
allowing them to earn profits. In equilibrium, the number of intermediaries will therefore
be equal to:
Number of intermediaries (r)
=
(m x n)/(m + n)
This, of course, is a highly simplistic view, but can be extended to cover all types of
transaction costs, besides cost of contact and communication. Hence retailers, for
example, reduce the search, negotiation and contracting costs between manufacturers and
consumers by providing a physical market place with assortment of goods produced by
different manufacturers. Although, it only explains the existence of middlemen in one
level, the logic can be extended further to explain the existence of wholesalers between
the manufacturers and retailers.
25
Baligh and Richartz (1967) developed the Balderston model further to estimate the
number of levels of intermediaries, besides the number of intermediaries at each level,
and the effect of the following variables on the these numbers:
i)
cost of information transfer
ii)
fixed cost associated with entry of middlemen
iii)
market segmentation and product differentiation.
According to their model, the number of intermediaries in equilibrium (as given by
Balderston) will be reduced if any of the above factors increase. For example, in a
segmented market, all buyers do not contact all sellers. Hence the total cost in a direct
channel will be relatively lower, thereby reducing the number of intermediaries possible
in equilibrium. Similarly, the higher the fixed cost of entry for an intermediary, the lower
would be their number in equilibrium.
Huff (1981) uses central place theory to estimate the size, spacing and number of
distribution centers (retailer locations) required to provide goods and services to a
dispersed population. The basic premise of his model is that the price of a particular good
to a consumer includes not only the retail selling price, but also the travel costs incurred
in going to the retail location. If 'm' represents the distance from a consumer's residence
to a retail store, and 't' represents the cost for consumer per unit distance, then the total
price paid by the consumer = p + mt, where 'p' is the selling price.
Price
Price
p + mt -----
p + mt -------
~~-----
Distac
I
m
Distance
P------Quan
IQuantity
q
q'
26
The retailer's demand will be a function of the total price for consumers (actual demand q
will be less than q', which is the demand retailers would face if there were no travel costs
for consumers). The market area of a retail store, given a selling price, can then be
represented by a circle with radius proportional to the demand for the store. The more the
number of retailers in an unsaturated market, lower will be the cost for consumers.
However, if the market is fully covered by existing retailers, additional retail locations
will encroach upon each other's market areas, making the size of the circles smaller.
The following table summarizes the various approaches described above and reviews
them in the context of the changed scenario of e-commerce:
Approach
Key hypothesis
Implications for e-commerce
The higher the market
concentration, the better the
viability of direct channel
Geographic market concentration
not much relevant in terms of
transactions, because of the ubiquity
of the Internet. In terms of logistics,
developed by
Bucklin (1966)
it is still important.
The more the service required by
consumers (smaller lot sizes,
faster delivery), the lesser the
viability of direct channel.
Bucklin (1966)
/Copeland
(1923)
Indirect channels are more suited
for convenience goods & direct
channels for shopping goods.
Bruce Mallen
(1973)
Marketing functions will align in
the channel based on who can do
them more efficiently.
Intermediaries will exist if they
reduce transaction costs.
Williamson
(1979) / Coase
(1992; 1937)
Anderson &
Weitz (1983)
Still relevant. However, the network
created by parcel companies like
UPS and FedEx has increased the
feasibility of direct channel even for
smaller lot sizes and faster delivery.
Still relevant. However, the Internet
is bridging the gap by making
comparison-shopping convenient
and inexpensive.
"Core competency" argument still
relevant.
Small manufacturers are better
off using indirect channel to take
advantage of economies of
Transaction cost of direct marketing
reduced drastically by the Internet.
May result in disintermediation of
traditional intermediaries and/or
creation of new types of
intermediaries.
Small manufacturers may find
Internet sales more viable than the
indirect channel because of global
aggregation.
reach of Internet.
27
Balderston
(1958)
Intermediaries exist because they
reduce contact and
communication costs.
Baligh &
Richartz (1967)
The higher the market
segmentation, product
differentiation and fixed cost of
entry, the lower the number of
The Internet may wipe out
intermediaries that exist only for this
reason, by providing a low cost
many-to-many communication
medium.
The Internet has drastically lowered
the fixed cost of entry for
information intermediaries. Hence it
will fuel growth of information
intermediaries.
intermediaries.
Retailers' demand is a function
of total price to consumers,
which is a sum of selling price
and travel cost to retail outlet.
Quite relevant. Direct corollary of
this theory is that the demand of
retailers will reduce because relative
inconvenience cost for retail has
increased with the availability of
convenient online shopping.
Huff (1981)
2.4 Impact of the Internet:
Downes & Mui (1998) describe the Internet as a "killer app", i.e. a product or service that
"winds up displacing unrelated older offerings, destroying and re-creating industries far
from their immediate use, and throwing into disarray the complex relationships between
business partners, competitors, customers, and regulators of markets."
The impact of the Internet on the channels of distribution has however been addressed
only sparsely in the literature, since the Internet phenomenon itself is quite new. Malone,
Yates and Benjamin (1989) were among the first to link transaction cost theory to
electronic communication, illustrating how electronic markets can lower the cost of
transactions and influence the formation of markets. In their view, electronic networks
encourage vertical de-integration of firms by lowering the cost of "buying" compared to
"making" in-house.
In the context of channel decisions, transaction cost theory can be applied in two ways.
Proponents of the threatened intermediaries hypothesis argue that a ubiquitous network
(such as the Internet), by extending into consumers' homes, lowers the transaction costs
28
producers incur when marketing directly to end consumers. However, the same
transaction cost theory can be used to argue that producers will outsource intermediary
functions, resulting in greater reliance on intermediaries.
Sarkar, Butler & Steinfield (1998) resolve this paradox by arguing that four different
possibilities exist depending on changes in relative transaction costs:
After Internet:
Before Internet:
T2
Intermediary
Intermediary
Producer
Producer
Consumer
T3*
Ti *
Consumer
In the pre-Internet scenario, intermediaries existed if TI was greater than T2 + T3.
Similarly, in the post-Internet scenario, intermediaries will exist if T1* > T2* + T3*. The
impact of the Internet on intermediaries can therefore be evaluated for four different
scenarios:
Before Internet
T1* < T2* + T3*
T1<T2+T3
T1>T2+T3
Internet supplements
Threatened
direct market
intermediaries
Cybermediaries
Internet supplements
W-
T1* > T2* + T3*
intermediaries
Threatened intermediaries scenario is only one of the four possibilities, happening if
Internet flips the relative transaction costs in favor of direct transactions. In other cases,
Internet could be supporting existing markets or creating new intermediaries (called
cybermediaries).
29
Balasubramanian (1998) analyzes the competition between direct channels like catalog
and the Internet, and conventional retail channels, using a circular spatial market model.
He establishes a mathematical relationship between the relative cost advantages of direct
channels vs. retail channels, and the equilibrium market share that can be established by a
direct marketer. His model uses a concept similar to the one introduced by Huff, in terms
of the travel cost for consumers being a major component in arriving at the retailer's
market share. Based on this model, he derives the following hypotheses:
1. If consumers have complete knowledge of product availability and prices in all
channels, the direct marketer acts as a competitive wedge between retail stores. Each
retailer competes against the remotely located direct marketer, rather than against
neighboring retailers.
2. Direct marketers will participate in a market if consumers' travel cost (including
opportunity cost of time spent on retail shopping and implicit cost of convenience) is
high and the disutility of buying direct (not so quick gratification, no physical
inspection before buying, product returns difficult etc.) is low.
3.
Under the assumptions of the model, direct marketer can get a maximum two-third
share of the market even if the disutility of buying directfor consumers is zero.
Not much empirical research has been done on estimating the sectoral impact of the
Internet on distribution channels. Reliable economy-wide statistics on Internet commerce
is itself difficult to find. A recent report entitled "The Emerging Digital Economy" (US
Department of Commerce, 1998) analyzes the importance of electronic commerce and
information technologies to the economy as a whole and to individual sectors of the
economy. Some important highlights are:
" The Internet's pace of adoption has eclipsed all technologies that preceded it. To
reach the 50 million users mark, radio took 38 years, TV 13 years, PCs 16 years, and
the Internet took just 4 years.
" Computing power has been doubling every 18 months for the past 30 years. At the
same time, average price of a transistor has fallen by six orders of magnitude.
30
e
Traffic on the Internet has been doubling every 100 days.
" In 1994, 3 million people used the Internet. In 1998, 100 million people were using
the Internet. Some experts believe that by 2005, one billion people may be connected
to the Internet.
" Analysts predict that business-to-business commerce over the Internet will grow to
$300 billion by 2002, still however representing just 3% of the total GDP.
"
Digital delivery of news and information saves
about
30-40
f tV
h toLtl cos oCL
newspaper or magazine.
" Cost of electronic ticket purchased by a consumer on the Internet is 1/8th the cost of a
ticket sold by a travel agent.
" It costs about a penny to conduct banking transaction over the Internet, while it takes
more than a dollar if handled by a teller at a branch bank.
" By a conservative estimate, Internet retailing is expected to reach $7 billion by 2000.
A recent study sponsored by National Retail Federation (E&Y, 1998) highlights some
important facets of Internet commerce. Some key observations from the study are quoted
below:
e
Today's online retailers expect the Net to account for a steadily increasing percentage
of their revenue, from 1% of total sales today to 9% for fiscal year 2001.
Manufacturers already selling online project that the Internet will represent 7% of
their total revenue by their fiscal year 2001.
" Consumers who are online but don't buy through the Net cite two main reasons: the
fear of giving out credit card information and the need to see the product before
buying it.
" Companies that view the Internet as an 'either-or' proposition are missing the point.
Web can be an influential sales channel, but it also can be a powerful medium for
driving purchases through more traditional channels.
" Why are computers, books, clothing, music, gifts, and consumer electronics among
the most popular purchases of online shoppers? It is a function of several things: the
demographics of Web buyers; the attributes of products and services they are most
31
comfortable buying through this new medium; and who has been selling the longest
on the Web to date.
* Who do retailers fear most in cyberspace? None other than the growing number of
startup companies whose storefronts exist only in the digital world - companies with
no physical investments to protect, no channel relationships to massage, and
comparatively less internal corporate politics with which to contend.
*
Manufacturers of consumer products got more aggressive about selling direct to
consumers through the Internet in 1998, yet the majority still do not sell online today
and have no plans to do so in the future - particularly those with annual sales of more
than $1 billion.
The impact technology (like the Internet) can have on the traditional business structures
is dramatically highlighted by the case of Encyclopaedia Britannica (Evans & Wurster,
1997), which was completely devastated by the advent of CD-ROM encyclopaedia. Since
1990, sales of the Encyclopaedia Britannica multi-volume sets have decreased by more
than 50 percent. The reason is simple: it costs in the range of $1500-$2200 to buy the
paper version, while an encyclopaedia on CD-ROM, such as Microsoft Encarta, sells for
about $50 and customers often get it free because it is bundled with their personal
computers as CD-ROMs. Interestingly, the largest part of Britannica's cost structure was
not the editorial content, which constituted only about 5 per cent of costs, but the direct
sales force. When Britannica realized the threat from CD-ROM encyclopaedias it created
a CD-ROM version, but to avoid undercutting its sales force, the company included it
free with the printed version and charged anyone buying the CD-ROM alone $1000.
Revenues continued to decline, the best salespeople left, and Britannica's owner, a trust
controlled by the University of Chicago, finally sold out. Under new management, the
company is now trying to rebuild the business around the Internet.
This case highlights the two most important issues in e-commerce:
1. Fundamental changes in business are required to adapt to the new environment.
2. Managing this transition is likely to be painful to the existing players because of the
inherent conflict with their existing business.
32
3 Research Hypothesis:
It is clear that the traditional role of intermediaries
is now undergoing major
transformation. Two factors have been primarily responsible for this:
1. Growth of the Internet.
2. Growth of small parcel logistics services.
These two factors combined have enabled the creation of an alternative marketing
channel in which the information service to consumers (or customer interface/ transaction
management) is provided by information while logistics service is provided by third party
logistics companies (like FedEx).
Before Internet:
Manufacturers
1,Wholesalers
Retailers
Consumers
After Internet:
Information
Intermediaries
Manufacturers
Wholesalers
Retailers
Consumers
33
The information intermediaries may be providing information to the consumer by
accessing information owned by (or available with) the manufacturer, wholesaler or
retailer. Similarly, the logistics service providers may be delivering goods to the
consumer after picking directly from the manufacturer, wholesaler or retailer.
It is apparent from the above discussion that there are various (dis)intermediation
possibilities depending on which channel structure is more efficient in satisfying
consumer needs and at the same time allowing the commercial channel (manufacturers
and intermediaries) to make profits in the long run. The normative channel structure may
be expected to be different for different industries based on consumer needs,
expectations, buying behavior and product characteristics.
The key hypotheses of this thesis are as follows:
HJ: The Internet will lead to a reorganization of vertical markets in terms of the
functions performed by various players, instead of complete disintermediation.Multiple
(dis)intermediation scenarios may emerge based on which player performs what
function.
H2: Traditionalintermediaryfunctions will split into distinctfunctions of information (or
transactionmanagement) and logistics. In certain industries, value-added intermediaries
will emerge that will support Internet commerce by filling the functional gap of trust and
service support.
H3: Growth of information intermediaries will be much faster than other types and its
impact on traditional intermediaries will depend on the consumers needs and product
characteristics.
34
Logistics
Intermediaries
Traditionally, retailers have provided both logistics and information services to
consumers; and wholesalers in turn have provided the same to retailers. The logistics
services include:
1. Reducing delivery lot size to consumers (they can't buy a truck/ pallet load of an
item).
2. Reducing waiting time for consumers (they can pick up goods from retail outlets
rather than waiting for delivery after ordering).
3. Providing easy accessibility to consumers.
4. Providing product assortment from different manufacturers.
The information services include helping consumers in:
1. Product search.
2. Merchant search.
3. Price search.
Besides these services, intermediaries also facilitate negotiation between buyers and
sellers; and, help in building trust in the market mechanism. However, with rapid
diffusion of the Internet, information flow can be de-linked with the logistics flow since
an alternate channel that is more efficient is now available. The exponential growth of the
35
Internet will lead to a much more rapid growth of intermediaries that provide information
services, in comparison to the logistics intermediaries. And to support commerce in the
new channel so created, new types of intermediaries will also emerge that will fill the
functional gap of trust and service support.
36
4 Restructuring of intermediary functions:
This chapter explores in greater detail the form and structure of the three types of
intermediaries introduced in the previous chapter. Section 4.1 describes the reason for
rapid growth of information intermediaries and the different types of information
intcrmCdiaries that have already come into existence. Section 4.2 describes the different
types of logistics intermediaries that allow sellers to sell directly to end consumers
without traditional intermediaries. Section 4.3 describes the types of value-added
intermediaries that are coming into existence to support e-commerce.
4.1 Information intermediaries
Based on model developed by Baligh and Richartz (1967), it can be argued that the
number of information intermediaries on the Internet will grow much faster than
traditional intermediaries or intermediaries providing logistics services. To illustrate this,
let's take a fictitious example where number of sellers (M) = 100, number of buyers (N)
= 1000 and the contact and communication cost (C) is $5. Let's assume that the
minimum level of return on investment (ROI) acceptable to any new intermediary
entering the market is 20% and fixed cost (F) associated with entry of information
intermediary is about
1/ 1 0 th
that of traditional intermediaries (in absolute terms, say
$5000 and $50000 respectively).
In equilibrium, the number of intermediaries (say Z) in the system will be determined as
follows: According to Balderston (1958) model, new intermediaries will continue to enter
the system till such point that the transaction cost in direct channel (M*N*C) becomes
equal to the cost in the indirect channel ((M+N)*C*Z). However, according to Baligh &
Richartz (1967), the entry of new intermediaries will stop much earlier due to the entry
barriers associated with the fixed cost (investment) needed for entry. The profit potential
is based on the difference in transaction cost between the direct and indirect channel. If
37
this profit potential falls below the expected minimum return on investment, new entrants
will be discouraged from entering the channel. Hence, in equilibrium, F*ROI*Z will be
equal to (M*N*C - (M+N)*C*Z). Therefore,
Number of intermediaries in equilibrium
= M*N*C/(F*ROI + (M+N)*C)
= 100*1000*5/(50000*0.2 + 1100*5)
=32
After the advent of the Internet, the number of intermediaries in equilibrium will be:
= 100*1000*5/(5000*0.2 + 1100*5)
= 77
Hence, the number of intermediaries more than doubles! The above example is highly
simplified but illustrates how the Internet can potentially impact the number of
intermediaries in a channel, though it is relevant only to the information function of the
channel. Hence the number of information intermediaries is likely to increase
dramatically in comparison to traditional intermediaries. As some part of the value added
by traditional intermediaries is taken away by these new information intermediaries, the
number of traditional intermediaries may actually come down over a period of time.
Sarkar, Butler & Steinfield (1998) argue that the ability of electronic networks to reduce
transaction costs will not result in bypassing of intermediaries in the electronic markets.
On the contrary, it will reinforce the position of traditional intermediaries and also
promote the growth of a new generation of intermediaries called "cybermediaries".
Based on this argument, they identify several types of cybermediaries that have already
come into existence:
1. Directories: these services help consumers find sellers by providing structured menus
to facilitate
navigation
and search.
Examples
are
general
directories
like
www.yahoo.com and commercial directories like 'The Embroidery Directory' by
www.ud.net.
38
2. Search services: allow users to conduct keyword searches of web sites. Examples are
www.lycos.com and http://infoseek.go.com/ (which have now actually grown out of
the search engines category and become more of Internet portals/ gateways).
3. Malls: allow consumers to visit commercial sites that are listed in this 'mall'. These
malls can have a geographic focus, like 'The Alaskan Mall' at http://alaskan.com/ or
an
aggregation
of
variety
of products/
sellers
like
'Cybersuperstores'
at
www.cybersuperstores.com.
4. Virtual resellers: are e-retailers that carry inventory in a few central locations and
sell their products to the consumers on the Net. Examples are www.amazon.com that
sells books, music, video etc., www.hugestore.com that sell men's apparel and
'International Shopping Club' at www.intsc.com that sells consumer electronics.
5. Web site evaluators/ Auditors: help consumers to reduce some risk by providing
some form of evaluation of web sites. Examples include GNN. Firms like Nielsen
(www.nielsen-netratings.com ) on the other hand help sellers evaluate the efficacy of
different sites for advertising effectiveness by providing audience measurement
services.
6. Financial intermediaries: are intermediaries that facilitate payment transaction
between buyer and seller. Examples include credit card companies like MasterCard
(www.mastercard.com/shoponline) and others like www.checkfree.com that provide
electronic equivalents of writing checks.
7. Spot market makers: allow buyers and sellers to transact in ad-hoc spot markets.
Examples
of
such
services
are
www.ebay.corn
and
BarterNet
at
http://www.telepot.con-dtpdx/bnhome.htm.
8. Intelligent agents: are software programs that allow users to specify the search
criteria to find products/ merchants that satisfy the criteria. Examples are
BargainFinder (started by Anderson Consulting, but now discontinued) and
www.firefly.com.
Hagel and Rayport (1997) argue that new technologies such as smart cards, World Wide
Web browsers and personal financial management software will allow consumers to take
ownership of information about themselves and demand value in exchange for it.
39
However, consumers will probably not bargain with sellers directly, but through
companies called "infomediaries". These infomediaries will act as custodians, agents
and brokers of customer information, marketing it to businesses on behalf of the
consumers, while protecting their privacy at the same time.
They argue further that the best candidates to play this role are companies that have
ongoing relationships with customers in a variety of commercial activities and have
earned their customers' trust. In this respect, banks for example will be better positioned
to become infomediaries than say retailers, who in turn will be better positioned than
individual manufacturers. Over time, this industry may become concentrated because of
economies of scope and increasing returns. Infomediaries with large and diverse
customer base will enjoy economies of scope over those with narrower customer base. In
addition, trust will provide increasing returns to the infomediaries and will raise the
barriers to entry for newcomers.
4.2 Logistics intermediaries
According to consulting company Deloitte & Touche (Wilder, 1997), there is a big
potential that distributors who do not add value can get replaced by freight companies.
Companies like FedEx and UPS, who have an established logistics network, are well
positioned to take this place in e-commerce. NEC for example (Fortune, 1994), has an
agreement with FedEx to manage its entire distribution network, enabling it to reduce
distribution cost from 2.6% of sales to 1.9%. It is not surprising therefore, that FedEx and
UPS have vowed (Computerworld, 1996) that everything a customer does today will
soon be done online- and their financial future depends on it. Both offer web-based
package tracking solutions with 10,000 to 13,000 users using the site for tracking
everyday.
Logistics services can also be provided by companies, who have developed an expertise
in direct order fulfillment, like Fingerhut (www.fingerhut.com). Fingerhut Business
40
Services (FBS) offers order fulfillment services to companies that do not own the
infrastructure to sell their products through catalog or online. For instance, Fingerhut has
a relationship with Levi's (www.levi.com) that works as follows: the customer places an
order for a pair of jeans on Levi's web site. The order is not handled by Levi's but by
FBS. FBS receives the order, packs the merchandise that is warehoused at one of FBS
distribution centers, and mails it to the customer. All service and product returns issues
are handled by FBS on behalf of Levi's. Similar services are provided by Hanover Direct
(www.hanoverdirect.com) through their Keystone Fulfillment Division.
4.3 Value-added intermediaries
By 2002, Gartner Group (www.gartner-group.com) predicts that 60% of wholesale
distributors will earn most of their profits from post-sale services such as installation,
warranty and training. Many value-added intermediaries have already come into
existence to support the trust and service requirements of consumers in e-commerce. For
instance, virtually all Dell warranty services are provided by third party vendors like
Unisys
Corp.
and
Wang
Global
through
their
PowerEdge
services
(www.dell.com/products/poweredge/service).
Similarly, for providing trust services, independent rating companies are coming up fast
in the e-commerce arena. www.bizrate.com continuously surveys thousands of actual
customers, as they buy online, compiling their shopping experiences into reliable
merchant ratings consumers can trust to shop online. A rating for computer seller
Cyberian Outpost (www.outpost.com) for instance, looks like below:
41
out of five stars
.................................
Rating
I Overall
..........
Ease of Ordering
Product Selection
Product Information
Price
Website
4*1|t
4|r*
4*ig**
4*lir
*4l& *4
Customers Surveyet 5546
ClearCommerce
On-Time Delivery
***1
Product Representation 1***
Customer Support
* ***
Privacy Policies
1**
Shipping & Handling
**
TIs PerIod: 2379
*
|1
Report Ped:d 1/5 /99 - 4 /5 /99
(www.clearcommerce.com),
a member
of the SET committee
established by MasterCard and Visa, provides an array of services, including credit card
authorizations, online order and payment processing, and fraud detection. During
processing, a buyer's credit card information is transformed into an unreadable format
after performing multiple checks for fraud. The fraud module verifies name and address,
defends against credit card number-generating programs, and locks out suspect card
numbers and IP addresses. Similarly, Verisign (www.verisign.com) is one of the leading
providers of Internet trust services.
42
5 Developing an integrated framework:
In this chapter, various theories of distribution channels, reviewed in chapter 2 are
integrated into a common framework with the objective of analyzing the sectoral impact
of the Internet on intermediaries. Section 5.1 outlines the key factors that affect
distribution channel structure and explains why certain parameters (like price) have not
been included in this thesis for analyzing the impact of the Internet. Section 5.2 describes
the impact of the Internet on these variables and relates it to the hypothesis outlined in
chapter 3, that three distinct types of intermediaries (information, logistics and valueadded intermediaries) can come together to provide an alternative to the traditional
distribution channels. Section 5.3 describes how consumer buying behavior can modify
the simplistic assumptions of section 5.1 and 5.2 and how it can be used to develop a
decision flowchart that can be used to understand the sectoral differences
in
disintermediation. Section 5.4 describes the flowchart and possible disintermediation
scenarios that may emerge.
The framework uses the following inputs to explore the changes in channel structure:
" Consumer needs/ preferences.
" Product characteristics.
" Environmental factors.
Integrated
Framework
43
The following steps were followed in creating a framework that can be used to
differentiate the impact of the Internet on distribution channel structure for different
industries:
1. Identify key variables affecting channel structure.
2. Exclude variables outside the scope of this research.
3. Identify the impact of the Internet on the selected variables.
4. Create a logical decision flow to understand difference among industries.
5. Evaluate different disintermediation scenarios based on the decision flow chart.
5.1 Key factors affecting distribution channel structure
From a review of the literature, following factors emerge as critical from the point of
view of determining the normative channel structure:
Key variable
Lot size
Reference
Bucklin (1966)
Waiting time
Bucklin (1966)
Assortment
Alderson (1957)/
Bucklin (1966)
Huff (1981)/
Balasubramanian
(1998)
Inconvenience
cost
Risk of purchase
error
Sarkar et al
(1998)
Search/
transaction cost
Balderston
(1958)/
Williamson
(1979)
Sarkar et al
(1998)
Service support
Customization
Bucklin (1966)
Relevance to channel structure
Smaller the lot size required by the consumer,
greater the need for logistics intermediaries.
Lesser the consumers' willingness to wait, greater
the need for logistics intermediaries.
More the assortment need of consumers, more the
need for aggregation intermediaries.
Higher the inconvenience cost of retail purchase
for consumers, higher the intensity of retail
distribution required; and higher the threat from a
direct marketer.
Higher the risk of purchase error in direct
purchases without physical inspection, higher the
need for intermediaries.
Greater the search cost for consumers, greater the
need for information intermediaries.
Greater the service support required by
consumers, greater the need for value-added
intermediaries who can provide after sales
service.
Higher the customization required by consumers,
higher the viability of shorter channel.
44
The impact of these key variables on the channel structure can be summarized in the
following influence diagram:
inconvenience
cost
risk
search cost
service support
customization
need satisfaction
transaction costs
waiting time
assortment
lot size
--
logistics
customer
requirements
satisfaction
channel flows
What this diagram implies is that the flow of goods and services through a channel finally
depends on how much the channel is able to satisfy the consumer needs and wants. These
consumer needs can broadly be categorized into three types: product needs, logistics
requirements and need to reduce transaction costs. Logistics requirements basically have
three components: lot size, assortment required and time consumers are willing to wait.
Transaction costs relevant to this analysis are: inconvenience cost, risk associated with
buying a product without physical inspection and search costs.
Product needs are basically definable in terms of product features, price, quality,
customization requirement and service support. Product features and quality can
generally be considered as independent of the channel structure, and hence have been
excluded from further analysis. Price is also excluded because in the short run, it is
generally a strategic variable for a company while in the long run, it is dependent on the
efficiency of the channel. For the purpose of this thesis, it is assumed that there is no
significant price differential between different channels in a specific consumer segment;
and if there is a price differential, it may be in either direction (i.e. direct channel price
may be higher or lower than indirect channel). The basic point here is that the direction of
price differential cannot be established without empirical research in a specific industry,
and hence is beyond the scope of this thesis.
45
Generally it is believed that the information efficiency of the Internet will bring prices
down because it will be easier to do comparison shopping online than through any other
venue (Goldman Sachs, 1997). Also, with the ubiquity of the Internet, retailers will now
have to compete on price with e-retailers and therefore the prices in general may go down
at least in the short run. Many online sellers are already passing on the savings in webcommerce to the consumers. For example, 1-800-Batteries (www.800Batteries.com )
offers a discount to customers for online sales because the cost of sales over the Net is
about half the cost for phone orders.
However, some studies done so far have not found any evidence of lower prices on the
Internet compared to traditional retail channel. One exploratory study done by Bailey and
Brynjolfsson (1997) did not find any evidence on the basis of data from 52 Internet &
conventional retailers for 337 distinct titles of books, music CDs and software.
It is actually very likely that Internet will enable new types of price discovery
mechanisms to be employed in different markets (Bakos, 1998). Traditionally, three types
of price discovery mechanisms have been used:
1. Auctions (sellers or buyers bid in specified formats).
2. Negotiations (sellers & buyers negotiate directly or through intermediary).
3. Firm offers (customers can take it or leave it, as in most retail markets).
In electronic marketplaces, intermediaries such as www.priceline.com can allow buyers
to specify product and price requirements and make corresponding offers to participating
sellers, reversing the traditional function of retail markets. Priceline is a buying service
that lets buyers request an offer at their price. Priceline then goes about finding a seller
who decides whether or not to fill the request. With Priceline, there is no auction, no
bidding and no back and forth.
Software agents such as Kasbah and Tete-a-Tete that can negotiate purchases on behalf
of buyers and sellers are also likely to restructure the price discovery process. The ability
46
to customize product offerings and the new emerging price discovery mechanisms may
allow sellers to also price discriminate- that is to charge different prices for different
buyers. It can be a powerful tool that allows sellers to increase profits or survive the price
erosion that may take place in friction-less electronic markets. It will also allow sellers to
service buyers who would otherwise be priced out of the market, thereby increasing the
overall economic efficiency.
As menu costs (cost of administering multiple prices) decrease due to the Internet's
transactional efficiency, sellers will move away from fixed pricing to flexible pricing.
This is already evident in the airline industry in U.S., which has increased profitability by
revenue management (another term for flexible pricing). Flexible pricing will also
counter price competition on the Net because consumers will find it difficult to compare
prices.
Goldman Sachs (1997) has developed an Internet Retail Index to assess the Internet's
ability to offer superior value to the consumers and the manufacturers, as defined by ten
criteria. The criteria used for developing the index and the associated hypotheses are:
1. Information-intensive products can be marketed more effectively on the Net.
2. PC-users make natural target consumers for online sales.
3. Products with low distribution cost as a percentage of gross profit are better suited
for Internet sales.
4. Products for which selection and prices change frequently are marketed more
effectively on the Net.
5. Selection-intensive, slow turning items are idealfor Internet selling.
6. Products for which delayed gratification is acceptable are suitablefor online sales.
7. Products for which 'touch and feel' is not essential are more easily sold over the
Net.
8. The Internetprovides access to higher-income customers.
9. The more appealing conventional retailing options are the less likely the online
sales.
47
10. Convenience is the key in online sales.
According to their analysis, products that are best suited for the Net based on above
criteria are:
1. Computer hardware
2. Computer software
3. Books
4. Music
5. Electronics
6. Office products
7. New vehicles
Products that are not so well suited for Internet sales are:
1. Home furnishings
2. Auto parts
3. Off-price apparel
4. Perishable food
It may be noted that unlike the research done by Goldman Sachs where they have
focussed on finding the suitability of online sales for different product categories, the
focus of this thesis is to find the impact of Internet on channel structure in terms of
disintermediation. While there may be some correlation between these two questions, the
first does not imply the second. That is, if a product is suitable for online sales, it does not
necessarily imply disintermediation.
Demographic variables, such as income, PC owner etc. are relevant for analyzing the
transient stages of the evolution of a normative channel. Since this thesis is primarily
concerned with the understanding of the normative channel in the context of e-commerce,
such demographic variables have largely been ignored in this research. Other parameters
used in this study are broadly covered in the key variables identified in the previous
section.
48
5.2 Impact of the Internet & 3PL services:
To understand the possible changes in channel structures for various industries, it is now
important to understand the impact of the Internet on the key variables identified in
Section 5.1. Besides the Internet, however, there is another factor that has impacted the
viability of direct channels: the growth of logistics services that have enabled the delivery
of small packages over long distances to individual consumers at a reasonable cost. The
following table summarizes the impact of the Internet and the availability of small parcel
logistics services on these key variables:
Key variable
Assortment
Impact of the Internet
Physical aggregation
capabilities not changed. Order
aggregation possible on
Impact of logistics
Viability
services
direct channel
Physical aggregation
possible by using
3PL.
Increases.
Increases
significantly.
of
Internet.
Inconvenience
cost
Internet has provided a more
convenient method of shopping.
No correlation.
Risk
No correlation.
No correlation.
Search cost
Dramatically reduced by
Internet.
No correlation.
Service
support
Self-service support possible
through Internet. No
correlationto physical service
support.
No correlation.
Customization
Lot size
Internet allows the possibility of No correlation.
one-to-one marketing and
customization.
No correlation.
Smaller lot size
delivery over long
distances has been
made viable by
Waiting time
No correlation.
Increases
significantly.
Increases.
Increases.
3PLs.
Faster delivery over
long distances has
been made viable by
3PLs.
Increases.
49
The above table shows that the combined effect of Internet and logistics services is to
potentially provide a viable direct marketing channel, except for two issues that are not
addressed by these factors:
e
Risk of buying a lemon (Ackerlof, 1970).
" Service support required by consumers.
Since the direct marketing channel has potential of enormous savings by reducing the
number of players in a vertical market, it is very likely that new forms of intermediaries
will develop who support this channel by independently providing services that address
the two issues identified above. These intermediaries may be called "value-added
intermediaries". Hence, an alternate channel to traditional wholesale/ retail channel
would be combination of three types of intermediaries performing distinct functions but
coordinating the overall activities with a view to satisfying consumer needs. The
traditional role of intermediaries may therefore spilt into three as shown below:
Dell's case
Information
intermediaries
Traditional
Intermediaries
f
Dell.com
Logistics
Intermediaries
FedEx
Value-added
Intermediaries
Unisys Corp.
Wang Global
For example, in Dell's case, the information and transaction interface with customers is
managed by the company itself through its web site; logistics is handled by FedEx; and,
service support is provided by Unisys Corp. and Wang Global. It may be possible for one
intermediary to provide more than one function. However, as described in an earlier
50
section, the number of information intermediaries will probably grow much faster than
the other two because of the exponential growth of Internet and the low entry barriers
associated with low capital costs of setting up a web site.
5.3 Consumer buying behavior
Although the previous sections identify the key variables that influence the consumers'
preference of one marketing channel over another and the impact of the Internet on these
variables, it needs to be recognized that consumers do not behave homogeneously even if
the basic needs/requirements are the same. Hence it is important to understand the
relationship between consumer buying behavior and the variables that determine channel
structure.
There are several descriptive theories and models that attempt to capture consumer
buying behavior-e.g. the Nicosia (1966) model, the Howard-Sheth (1969) model, the
Engel-Blackwell (1982) model and the Bettman (1979) information processing model.
Although different in their approaches, these models share a similar list of six
fundamental stages guiding consumer behavior:
1. Needs identification: consumers become aware of some unmet need.
2. Product brokering: evaluation of product alternatives.
3. Merchant brokering: evaluation of merchant alternatives.
4. Negotiation.
5. Purchase & delivery.
6. Product service & post-purchase evaluation.
The following table maps the key variables identified in the previous section in terms of
their importance to these stages of consumer buying behavior (CBB). It suggests that
assortment, customization and search cost are the only variables that are important in the
initial stages of CBB, while the other variables are important only for the later stages.
51
Need
identification
Lot size
Wait time
Assortment
Inconvenience
cost
Risk
Search cost
Service
Customization
Price
Product
brokering
Merchant
brokering
Negotiation
Purchase
&delivery
Service &
evaluation
/
V
//
/
V
//
_
/
Hence, assortment, customization and search cost could be thought of as primary filters
that eliminate many channel possibilities in the initial stage itself, or at least significantly
alter the balance in favor of one channel type over the other. For example, if the
consumer needs an assortment of goods produced by different manufacturers (say basket
of grocery items), it is very unlikely that s/he will purchase directly from the
manufacturer, since the consumer knows instinctively that the cost of doing that will be
very high.
Similarly, if the consumer requires customization of the product to suit his/ her needs,
and the original manufacturer can do the customization more efficiently, a direct channel
will be more likely. For example, while Amazon.com and other cybermediaries have
been very successful in selling standard books over the Net, when it comes to
customization, publishers are more likely to provide that service (since they control the
printing process). McGraw Hill's college division pioneered the concept of customized
textbooks: its Primis service (www.mhhe.com/primis) allows customers to select
modules from different sources to create a customized textbook suited to the pedagogical
style or objectives of an instructor.
If the consumer requires a lot of information in order to decide what to buy, or from
whom to buy (may be because of the technical complexity of the product), s/he will
52
probably depend on an information intermediary to help with information collection or
decision making.
In the Merchant brokering stage, all nine variables become important, but the consumer
implicitly determines the expected inconvenience cost and risk involved in different
channel options and reduces the consideration set based on these. For example, a
consumer planning to buy apparel may decide against catalog/ Internet purchase because
s/he doesn't want to take the risk of buying without touching or feeling the texture of the
fabric. S/he may actually move back and forth between this stage and the next stage
(Negotiation) in an iterative process before selecting a merchant, but negotiation
generally involves only the following variables: lot size, delivery time, service,
customization and price. Inconvenience cost and risk can therefore be considered as
secondary filters that further narrow down the channel choices for the consumer.
Channel Choices
.
.
Need identificationAsote,
Needuct
idkentain
Product brokering
Merchant brokering
Negotiation etc.
.Assortment,
Customization,
Search cost
Inconvenience
cost, Risk
Primary filter
Secondary filter
Lot size, wait
time, service,
price
The concepts described above are used later in the next section to develop a decision
flowchart to understand the various (dis)intermediation
possibilities for specific
industries.
Variance in consumers' purchase motives is another important issue in relating the
consumer buying behavior to channel preference. It will be too simplistic to say, for
example, that a consumer would buy directly from a manufacturer (instead of an
53
intermediary) because his/ her requirements as defined by the key variables identified
above are satisfied better by direct channel. It is quite impossible to straitjacket consumer
buying behavior in such a manner. Extensive research, in fact, has been done in retailing
to understand consumers' purchase motives. Samli (1998), for example, classifies
consumers' purchase motives (in retail shopping) into nine categories:
1. Diversion
2. Self-gratification.
3. Learning about new trends.
4. Physical activity.
5. Sensory stimulation.
6. Social experiences.
7. Pleasure of bargaining.
8. Clearly identified needs and wants.
9. Specified pressures to shop.
From the above list, it is clear that Internet shopping can satisfy only some of these
purchase motivations. However, technology is fast bridging the gap by creating
intelligent software agents that can satisfy to some extent, even the pleasure of
bargaining. Most software agents developed so far help a consumer in the search process,
whether it is related to product, merchant or price. Some of the more developed versions
however, can negotiate on behalf of the consumer. Guttman, Moukas & Maes (1998)
compare some of the software agents in the context of the consumer buying behavior
(CBB) model described above:
CBB stage
Product brokering
Merchant brokering
Negotiation
PersonaLogic
Firefly
Jango
Kasbah
Tete-a-tete
Firefly uses an automated collaborative filtering process that can be used to match users
with similar profiles and make recommendations based on their shared interests. Tete-atete uses a combination of multi-attribute utility theory and distributed constraint
54
satisfaction problem protocols (CSP) to negotiate. CSP techniques are used to encode
hard constraints like: I'm not willing to spend more than $2000" and soft constraints like
"availability is more important than price".
Most Internet commerce sites now incorporate some kind of software agents and
interactive tools that attempt to bring the retail shopping experience to the consumers'
desktops. A case in point is NetMarket.com, a site run by membership discounter CUC
(now
Cedant
Corporation).
It
has
an
innovative
haggle
zone
(www.netmarket.com/SHP/scripts/HaggleZone.asp) that perhaps gives to the consumers
the pleasure of bargaining more than real bargains. Another interesting example is
www.sunglasshut.com, who is planning an interactive feature on their web site that will
allow users to download a digital image of themselves to the site for virtual sun glass tryons. In the final analysis, however, some of the retail shopping experiences may never be
possible to simulate on the Internet. To that extent, the relationship between the key
variables being studied and the expected channel structure, as developed in the next
section, will be weakened and will need to be established for specific customer segments
by empirical research.
5.4 Decision Flowchart
The relationship between the key variables and the channel structure based on the
consumer buying behavior can be qualitatively represented by the flowchart shown on the
next page. The following hypotheses are built into the flowchart:
1. Consumers are likely to prefer a direct channel if they do not require an assortment
of products manufactured by different producers.
2.
Consumers are likely to prefer a direct channel if they want customized products that
manufacturers are in a better position to provide.
3. For information-intensiveproducts, consumers are likely to depend on information
intermediariesto help them in their search and selection process.
55
4. Consumers are likely to prefer retail channel if it is not very inconvenient to purchase
from retail outlets and if the risk of purchase error cannot be mitigated without
physical inspection.
5. If the product is amenable to logistics services provided by independent third party
logistics service providers (defined as UPSable in this thesis), the purchase
transactions may occur independent of logistics, increasing the viability of
cybermediaries.
6. For products suitable for cyber sales, independent value-added intermediariesmay
fill the functional gap of service and risk-mitigation.
56
0
y
y
00
0
0
57
Based on the logic of the flowchart as applied to various industries, as many as five
different intermediary structures can be expected to evolve, depending on how the
transaction and logistics functions are divided between different players in the channel:
Logistics function by:
Retailer
Wholesaler
Mfr.
Retailer
C
.EZ
C
Cybermediary
Cu
Cu
Manufacturer
For example, in scenario J), retailers perform both functions while wholesaler facilitates
the logistics function, which has traditionally been the case. In this scenario, the Internet
may help the consumers only in searching for products, merchants and prices. In terms of
degree of disintermediation, scenario 1 to 5 represent increasing disintermediation as
shown below:
High
Disintermediation
Of Logistics function
High
Low
Disintermediation of
Transaction function
58
While the economics of logistics function has not changed drastically in the last 4-5
years, the economics of who can manage the transaction function (i.e. customer interface)
has changed considerably due to the explosive growth of the Internet. Since everyone
wants to be closest to the customer in order to capture maximum value in the demand
chain, there is a race among the various players to occupy the consumers' top-of-mind
cyberspace. On the other hand, conflict with their existing business pushes these players
in the opposite direction. Hence, scenario
@
and
@
can be considered to be
fundamentally unstable and moving towards their natural equilibrium over a longer
period of time, based on who can provide more efficient logistics.
In the long run, Scenario
@
is likely to merge with scenario
disintermediated by the cybermediary, or scenario T
cybermediary space. Similarly, scenario
@
4
with the retailer being
with retailer occupying the
is likely to merge with scenario
@
with
manufacturer disintermediating the wholesaler and retailer after overcoming channel
conflict. In this long-run equilibrium, the channel structure will be determined primarily
by logistics and marketing considerations and the customer interface will be managed by
the last entity in the channel.
From the above discussion, it is clear that 'disintermediation' is not a 'yes' or 'no'
question. There are various shades of disintermediation possible. Next section analyzes
these scenarios in greater detail in reference to different industries and the major players
in these industries.
59
6 Exploratory Analysis:
This chapter explores in greater detail, the disintermediation scenarios introduced in the
previous chapter, specifically in terms of their applicability to various industries. The
analysis is exploratory in nature and needs to be supported by empirical research and
detailed case studies. However, the current state of Internet commerce is in a highly fluid
stage rendering empirical research difficult and deriving conclusion from such research
even more difficult. Section 6.1 describes the five disintermediation scenarios in terms of
the market characteristics and consumer buying behavior explained via the decision
flowchart as it applies to different industries. Section 6.2 provides a more in-depth view
for two industries in the form of case studies and section 6.3 briefly outlines some of the
limitations of such exploratory analysis.
6.1 (Dis)intermediation scenarios:
Scenario (
In this scenario, consumers only research the information required (on products,
merchants, prices etc.) on the Internet and finally buy from traditional retail channel. This
is likely to happen for products where:
" Assortment is required by customers, and/or
e
Customization is not required, or if required, cannot be economically provided by the
manufacturer. In this case, customization may be provided either by the retailer or by
independent value-added intermediaries. An example would be customized jewelry,
furniture or bicycle.
" Risk of purchase error is high and cannot be mitigated without seeing the product, as
may be the case for apparel.
The decision flowchart for purchases in this category will be a subset of the generic
flowchart described in the previous section, and would look as follows:
60
y
For information-intensive products, even though consumers may buy from retail, they
may use the Internet to search for the right product or merchant using informationintermediaries or "infomediaries". Examples include general search engines like
www.yahoo.com, intelligent software agents like www.firefly.com and industry specific
intermediaries like www.autobytel.com for auto industry and www.pricewatch.com for
computer industry. The distribution channel for such goods will look like the following:
Manufacturers
0,Wholesalers
Retailers
Consumers
Infomediaries
Home furnishings (e.g. furniture) and apparel are likely to fall in this category. It may be
noted that the risk of purchase error is a very real and important issue for consumers in
direct purchase. This is reflected in the high percentage (25-40%) of returns (Goldman
Sachs, 1997) for apparel mail order catalog companies. A report published by market
61
research
firm
Cyber
Dialogue
(www.sonnetech.com/corporate babble/pr27.html)
indicates that 60% of Internet shoppers do not trust the color they see on their monitors.
The study further reports that about 30% of online shoppers decided not to purchase a
product because the true color of the product was in doubt and almost 15% of shoppers
returned items because the online color did not match the actual product that was
delivered. There will, of course, be some consumers (albeit not a large proportion) for
whom risk of purchase error is not important or, they have already experienced a specific
brand and therefore the risk of buying the same brand again without seeing is not very
high. Such consumers may prefer to buy from a cybermediary, as discussed in scenario 2.
Apparel became AOL's e-commerce category leader in 1997, surprising nearly every
industry analyst. However, e-commerce revenues accounted for only 3.8% of total retail
sales in 1997, and few expect the Internet to savage the $169.2 billion retail apparel
industry. Strongest online entrants are retailers from the catalog world (which is about
$14 billion market).
www.eddiebauer.com complements its retail and mail order business with its web site
that has excellent options of product search, catalog request, virtual dressing room, store
locator, wish list, reminder service & weekly specials. It's Virtual Dressing Room lets
shoppers maneuver actual photos of clothing with click and drag-and-drop ease to
virtually build and view coordinated fashions.
www.landsend.com, the largest catalog
company has an interactive shopping with real-time inventory access on its web site.
Lands'End Inc. decided to close 3 out of its 19 stores because it found catalog and
Internet to be much more cost effective that outlet stores in liquidating overstock and
end-of-season inventory (Computerworld, 1999). www.fashionmall.com, the first online
apparel store has a wide assortment of products and links to sellers. www.gap.com is one
of the few non-catalog-based brands that made a quick transition to Net commerce. The
Gap Online Store, which opened in 1997, creates an exciting and interactive shopping
experience. Some of the big names in retail like Neiman Marcus, Nordstrom, Gucci &
Hugo Boss have however not aggressively deployed an Internet strategy. It seems that
62
these companies believe that the social experience of shopping in stores for high-end
apparel overrides Internet-based advantage.
Levi Strauss & Co. (www.levistrauss.com), the world's largest brand-name apparel
manufacturer with 1998 sales of $6 billion, opened its Online Store in November 1998
and now offers a broad selection of Levi's apparel. VF Corporation (www.vfc.com),
world's largest publicly held apparel company (owners of Lee & Wrangler brands),
launched its e-commerce initiative in February 1999 by making its Healthtex brand
available online for retailers. Finding a way to better support retailers was the primary
impetus for developing the site. According to Mackey McDonald, chairman of VF
Corporation, their primary effort is to develop a collaborative partnership with their
retailers, complemented at some time in the future by a direct-to-consumer capability to
ensure broad coverage of the combined consumer base (www.vfc.com/frame news.html).
With strong brand names in retail industry in the forefront of Internet commerce and
manufacturers lagging behind, disintermediation seems to be an irrelevant possibility in
apparel industry.
Home furnishings: The $31.8 billion home furniture segment so far comes in dead last
in the race to hit the Internet. Most analysts say furniture is too heavy to ship and too
expensive & sensory dependent to buy unseen (Forbes ASAP, 1998). Small appliances,
home accessories, and soft textiles such as towels and sheets fit the Net better.
www.eddiebauer.com has been selling on the Net since 1994 and now offers more than
1200 products online. However, the cost of delivery is as high as 20-25% of the price of
the furniture and order fulfillment takes a considerably long time. For larger furniture
items that are a manageable size, shape and weight, and are easy to assemble, there is a
Basic Freight service to deliver the boxed furniture to the customer's door. Basic Freight
ships in 2 to 4 weeks with additional 10 business days for transit. This implies that the
customer has to wait for more than a month to get delivery. For all larger-sized or
unwieldy pieces, there is a White Glove Delivery service that ships in 4 to 6 weeks with
additional 3 weeks for transit. For furniture that can be delivered by UPS, it is usually
63
shipped in 1 to 2 weeks with additional 8 business days for transit. UPS rates for furniture
are based on UPS charges for "oversized" packages. With such high cost and wait time
for delivery, online market for furniture will probably remain a small niche.
Scenario
@
In this scenario, consumers buy the goods on the Internet, but the goods are shipped from
a retail outlet to the consumers or picked up from the retail outlet by the consumers. In
this case
the
wholesalers
& retailers
perform
the
logistics
function,
while
"cybermediaries" perform the transaction function. Additionally, the "last-mile"
logistics function may be performed by the retailer or a local logistics service provider
coordinated by the cybermediary. This is likely to happen for products where:
* The consumer requires assortment of standard products (e.g. basket of grocery
products purchase every week).
*
Retail is inconvenient and risk of purchase error is either low or can be mitigated by
an intermediary.
*
Product is not UPSable.
64
The distribution channel for this category will look like the following:
Manufacturers
Retailers
Wholesalers
Consumers
Cybermediaries
This channel structure appears to be suitable for products like groceries. It is very likely
that retailers will occupy the cybermediary space in this channel. However, for now the
major retail chains, which dominate the U.S. $426 billion grocery business, aren't willing
to take too many risks on the Net, but are backing online-based newcomers to test the
waters. That may be because food retailing is a low-profit (1.0% industry-wide), highperishable business that's not especially well suited to e-commerce, despite its
convenience factor.
www.peapod.com for example, has partnered with Safeway, Kroger's and Stop & Shop.
www.homeruns.corn is backed by $3 billion food retailer Hannaford. However, one of
the biggest U.S. food chains, www.winndixie.com ($13 billion in 1997) is not selling
online. The general format evolving is that online retailers (cybermediaries) either are
tying up with retail chains or big retail chains are themselves getting into online business.
The level of disintermediation in this category can therefore be expected to be
insignificant. However, CUC International Inc. is trying a different approach through
www.netgrocer.com, a part of a much broader strategy to sell almost everything a
consumer may want on the Net (www.netmarket.com). This strategy disintermediates the
retailer and is discussed in greater detail in scenario 4.
Scenario
@
In this scenario, consumers buy the goods directly from the manufacturer at its web site
but the goods are delivered to, or picked up by the consumer from the retail outlet. This is
likely to happen under following conditions:
65
e
No assortment is required
" Product is information intensive.
" Retail is inconvenient.
*
Risk of purchase error is either low or can be mitigated by an intermediary, and
e
Product is not UPSable.
The decision flowchart for this category will be as follows:
y
66
Actually, these conditions favor total disintermediation (as discussed in scenario 5),
except that the logistics for these products is difficult or uneconomical if managed by the
manufacturer without wholesalers and/or retailers. This scenario may therefore also
represent a transient stage for a channel that may eventually evolve into a direct channel
(implying complete disintermediation), but is currently unable to move towards its
natural equilibrium because of channel conflict. In the computer industry, the channel
conflict is already evident with companies like Compaq and HP trying all possible
strategies to participate in the rapidly growing online market while making sure that their
relationships with the existing channel are not jeopardized.
Many home appliance companies redirect consumers to e-retailers to avoid channel
conflict or to experiment with online sales without directly getting involved. For
example, LG Electronics (www.lgeus.com) redirects consumers who come to its web site
to buy online, to Internet retailer Today's Merchandising, Inc. (www.shoppingtoday.com).
The channel for this category will look like the following:
Manufacturers0-~
1
loWholesalers
Retailers
Mfr.'s web site
Infomediaries
Consumers
-0
-
Large consumer appliances and cars are likely to fall in this category. Auto retailing is a
$500 billion business in the U.S. and accounts for up to one third of the final price to the
consumer (Fortune, 1996). For logistical and legal reasons, consumers may always have
to depend on a franchised dealer, but Internet greatly facilitates the most difficult part of
the purchase process: information search and comparison-shopping. Selz and Klein
(1997) have identified the emergence of two types of cybermediaries: automotive service
brokers and automotive information brokers. www.autovantage.com is a broker service
67
that brings together potential buyers and sellers. Autovantage forwards a potential
customer's inquiry to a dealer close to the customer, who then offers a price within two
working days. Similar service is provided by www.autoweb.com, www.autobytel.com
and www.dealernet.com. However, these cybermediaries basically link the customer to
the nearest dealer after s/he has decided on the model to buy. Manufacturers have also
now entered the fray, and can potentially provide more value addition than independent
cybermediaries with real-time inventory information and customization possibilities. For
example, at http://www.gmbuypower.com/, a GM customer can, after identifying the
model s/he is planning to buy, choose an actual vehicle right down to the Vehicle
Identification Number (VIN). A potential customer of Ford (www.ford.com) can customconfigure a car on its web site in terms of the powertrain, exteriors, interiors, audio,
wheels/ tires etc. and then request for a dealer quote for the customized car. Hence, in the
long run, it is likely that consumers will use information intermediaries to do preliminary
search, then buy the selected/ customized car directly from the manufacturer and take
delivery from the nearest dealer.
Scenario
@i
In this scenario, consumers buy the goods on the Internet, and the goods are shipped from
a central warehouse (or a few warehouses) directly to the consumers. This is likely to
happen for products where:
" The consumer requires assortment.
*
Product is information intensive (search effort and cost is high).
" Retail is inconvenient and risk of purchase error is either low or can be mitigated by
an intermediary.
" Product is UPSable.
The decision flowchart for purchases in this category will be as follows:
68
y
In this case the retailers are disintermediated, while "cybermediaries" perform the role
of electronic retailing and physical wholesaling. This would be possible only with the
logistics support from parcel companies like FedEx or UPS. Examples include
www.amazon.com and www.buy.com who are linked to the wholesalers for physical
logistics or own the wholesaling function also. The channel for this category will be as
follows:
69
This scenario appears likely for products like books, toys, wine, music CDs and video.
Catalog marketers who have turned to e-retailing are essentially using this model to reach
directly to the consumers. Cedant Corporation (earlier CUC International, Inc.) for
instance, started an electronic superstore (www.netmarket.com) that sells more than
250,000 brand-name products at a hefty discount of 10% to 50% off the manufacturer's
price list (BusinessWeek, 1997). To get those discounts, CUC has set up NetMarket like
its regular shopping clubs where the discounted rates are made possible by membership
fees.
Traditional music CD & video outlets could be in greatest danger from online shopping
sites. "This is one industry that will be rocked by e-commerce," predicts Piper Jaffray's
Bill Burnham (www.piperjaffray.com). While online music revenues accounted for just
$71 million of the $12 billion U.S. market in 1996, analysts predict that online revenues
will easily double in 1999.
One thing that is common among all the online sellers is that they offer a huge variety of
titles that is impossible to match for a traditional retailer. www.towerrecords.com sells
more than 200,000 music titles, commanding 14% of online sales in this category.
www.columbiahouse.com is the second most popular site on web. www.cdnow.com, the
first
online-only
CD
seller,
recently
teamed
with
up
MusicBoulevard
(www.musicblvd.com) to offer an impressive array of more than 250,000 titles.
www.reel.com offers more than 35,000 video titles for rent and 85,000 titles for sale. On
the
other hand,
the
big
retailers
have
been
slow
in
embracing
the Net.
www.virginusa.com has about 60 megastores worldwide, but is not selling online and
www.blockbuster.com started selling online only in 1998.
Toys (total U.S. market is about $22 billion) are terrifically suited for online sale: usually
small, easy to ship, kids don't need to try them and convenient for parents. Several
companies have launched toy business on the Web in the past two years, from Internetonly resellers such as eToys Inc. (www.etoys.com) and WebMagic's www.toys.com to
well-known retailers such as FAO Schwarz (www.faoschwarz.com). All offer hundreds
70
of products available for immediate delivery. Consumers also find shopping hints and
buying guides designed to make it easier to find the right toy. FAO Schwarz carries over
250 products and plans to expand online selection to more than 1000 products. Holt
Educational outlet has gone much further and provides a selection of over 20,000 items to
search from. Its e-commerce site has proven so successful that the company has
abandoned plans to open new brick-and-mortar
storefronts, deciding instead to
concentrate on its web site (Sales & Marketing Management, 1999). As usual, the big
brands like Mattel and Hasbro have shied away from Internet commerce for fear of
disrupting their distribution channel.
Wine & spirits: Although online potential of wines & spirits is high, currently it is
limited by a regulatory environment that prohibits the transfer of wines and spirits across
state lines. www.klwines.com was voted as one of the best online wine retailer by Money
magazine. Virtual Vineyards (www.virtualvin.com), founded in 1994 is one of the most
talked about wine e-retailer. It offers advice as well as wines on its site. Virtual
Vineyards is one of the few online merchants to offer the digital cash payment service.
Again as in other categories, the big retailers have been slow to react. www.ejgallo.com,
the granddaddy of jug wine retail does not offer its wines online.
Scenario
@
In this scenario, consumers buy the goods directly from the manufacturer at its web site
and the manufacturer ships the goods directly to the consumer using third party logistics
service providers. This implies complete disintermediation by the manufacturer (Most
quoted example of this case being www.dell.com). This is likely to happen for products
where:
" No assortment is required
e
Customization is required and can be economically and more efficiently provided by
the manufacturer.
" Product is information intensive
" Retail is inconvenient
71
"
Risk of purchase error is either low or can be mitigated by an intermediary, and
*
Product is UPSable.
The distribution channel for this category will look like this:
Manufacturers
Mfr.'s web site
Logistics
Intermediaries
The decision flowchart for purchases in this category will be as follows:
72
Computers and consumer electronic products will fit into this category. The case for
computers is discussed in detail in the next section.
Consumer electronics is a $166 billion market, and even though there is tremendous
potential for direct sales to consumers, very few companies are addressing it online. One
reason for this may be the absence of early adopters or innovators like Dell in this
market. Consumer electronics was ninth in online sales in 1997 behind such retail
segments as jewelry. However, Forrester Research (www.forrester.com) expects the
market to triple in the next two years.
As may be expected, the first movers in this market are retailers from the catalog/ direct
marketing world. www.igvc.com, the no.1 general merchant on television, has more than
100,000 products on its web site. www.crutchfield.com is another direct mailer
leveraging its direct marketing experience on the Internet. www.netmarket.com provides
an interactive & entertaining shopping for more than 10,000 electronic items from more
than 300 manufacturers.
Consumer electronic manufacturers have, on the other hand, not been aggressive on the
Net till recently. www.panasonic.com has put up an electronic catalog on the Net, but
does not give the option of buying online. www.sony.com similarly has an extensive
electronic catalog, but only computers, digital cameras and accessories are available for
shopping online. The manufacturers are clearly going slow in order to avoid channel
conflict. However, as noted earlier, the potential for disintermediation is quite high in
consumer electronics, and therefore it may be a matter of time before the manufacturers
start offering their complete range online.
73
A summary of differences in (dis)intermediation for different industries that may emerge
in e-commerce is given below:
Parameter
Books
Music/
Toys
Computers
Video
Consumer
electronics
Assortment
Customization
Info search
Risk
Service support
UPSable
Transaction by:
Logistics by:
Types of
intermediaries
Likely scenario
y
n
y
n
n
y
C/M
W/S
C/M
L/IM
y
y/n
y
n
n
y
C/M
W/S
C/M
L/IM
y
n
y
n
n
y
C/M
W/S
C/M
L/IM
n
y
y
n
y
y
Mfr.
L/IM
I/M
VA/IM
n
n
y
n
y
y
Mfr.
L/IM
I/M
VA/IM
Parameter
Assortment
Customization
Info search
Risk
Service support
UPSable
Transaction by:
Logistics by:
Types of
intermediaries
Likely scenario
Groceries
y
n
y
y/n
n
n
R,C/M
R
C/M
R
(;i
Apparel
y/n
y/n
y
y
n
y
R,C/M
R, L/IM
C/M
R, VA/IM
Cars
n
y/n
y
y
y
n
Mfr.
R
I/M
R, VA/IM
Furniture
y/n
y/n
y
y
n
n
R,C/M
R
C/M
R, VA/IM
Wine
y
n
y
n
n
y
C/M
W/S
C/M
L/IM
R
Retailer
W/S
Wholesaler
Mfr.
Manufacturer
L/IM
Logistics Intermediary
I/M
Information Intermediary
C/M
Cybermediary
VA/IM
Value-added Intermediary
74
Based on the above mapping for key variables, the likely scenarios for these nine
industries will look like the following on a linear disintermediation scale:
z
W
io
@W
O0~
~
o@*
High disintermediation
Low disintermediation
And on a two-dimensional disintermediation grid (one axis representing transaction and
the other logistics), the likely scenarios will look like the following:
High
Low
High
Disintermediation of
transaction function
Next section provides a more detailed analysis for following two industries:
e
Books (representing key requirement of assortment and search).
*
Computers (representing technical complexity and customization requirement).
75
6.2 Case studies:
6.2.1
Books:
At more than $20 billion (1996), the book industry is growing at a slow but steady pace,
about 3% annually in recent years (Hoover's, 1999). Book superstores such as Barnes &
Noble and Borders Group and newer virtual superstores such as Amazon.com have had a
tremendous influence on the industry in recent years.
Amazon.com (www.amazon.com) is one of the pioneers of Internet commerce and
perhaps the best known bookseller on the Internet. Jeff Bezos started Amazon.com when
he saw that there was a broad field of book publishers but too many titles to be carried by
a single store (Hoover's, 1999). Amazon's well-publicized success as an online
intermediary is the result of a database of more than a million titles in its virtual inventory
and its use of Internet technology for developing communities in a way that a traditional
book retailer cannot replicate (A.T.Kearney, 1999). Amazon now offers an easily
searchable trove of 3.1 million titles--15 times more than any bricks-and-mortar
bookstore, without the related overhead. Its 1,600 employees generate, on average,
revenues more than triple that of No. 1 bricks-and-mortar bookseller Barnes & Noble
Inc.'s 27,000 employees (BusinessWeek, 1998):
Amazon
Barnes & Noble
No. of stores
1 web site
1000+
Titles per superstore
3 million
175,000
Book returns
2%
30%
Sales per employee
$375,000
$100,000
Inventory turns
24
3
76
Amazon's success with books is also due to the fact that books are quasi commodities
(Willis, 1998) - there is no need to try them on before you buy- and that they are smallticket, impulse items that are easy to ship.
Following the logic of the flowchart given in Section 5.4, it is clear that the books have
high potential for online sales by cybermediaries and the retailers stand the greatest risk
of disintermediation. The wholesaler is needed because the large number of publishers
and consumers make physical aggregation almost impossible without a logistics
intermediary. The following flowchart shows why disintermediation of the retailers is a
strong possibility in this industry:
y
y
Disintermediation of retailers in the book industry is already evidenced in the closing
down of small independent booksellers like Waking Owl Books in Salt Lake city,
77
Baxter's Books in Minneapolis and Printers Inc. in Palo Alto, California (WSJ
Interactive, 1999). Hence, the distribution channel evolving in books is as follows:
Publishers
joWholesalers
Ret
Consumers
rs
'ACybermediaries
Logistics
Intermediaries
Amazon.com started as a cybermediary without doing the physical aggregation function
itself and instead depending on wholesalers like Ingram Book Group (www.ingram.com),
which is the largest wholesale distributor in US, serving more than 32,000 retail outlets
and representing more than 12,000 publishers. However, with the takeover of Ingram
Book by Barnes & Noble, Amazon is now strengthening its distribution network by
establishing its own distribution centers (The New York Times, 1999). Before the
Ingram/ Barnes & Noble deal, Amazon's supply chain looked like the following:
Publishers
pConsumers
Ingram/
Amazon's DC
Amazon
'
Barnes and Noble, under threat of disintermediation, did the obvious thing, of integrating
backward (by buying Ingram) and opening its own web site. The acquisition has given
Barnes & Noble tremendous leverage in distribution channel and capability to service
online customers directly from key distribution centers. This shows how the Internet is
reshaping the structure of the distribution channels and how the changes in efficiency of
information aggregation and flow is resulting in the reorganization of the functions
performed by the intermediaries. The distribution network for book industry in the US
after the Ingram acquisition is shown below (Christian Science Monitor, 1999):
78
Book distribution centers
Barnes & Noble's purchase of Ingram, the country's leading book
wholescler, is reshaping the US publishirg industry.
Seattle
m Roseburg,
ardsbur.
Chanbersburg,
Pb.
M--
Ore.
Reno,
ONev.'
Beleville, Mich.
Ann Arbor, Mich,-O
Fort Woyne, Ind.*
indionopolis
Denver
.1
East Windsor,
Conn.
0
tNew Castle,
S Chino, Colif.
0 Ontario, Calif
F.
Det
Nashville, Tenn.* (4!sites)
La Vergne, Tenn. (2 sites)
-
Petersburg,
Va.
Newport, Tenn.
a tngram
o
Borders
SAnozon.om
}
*Return Conter
Jc&AN
M~wQvj
Soiace j.FPMhixar
In fact, Barnes & Noble has gone even a step further. It purchased Lightning Print Inc, a
print-on-demand publisher in Nashville and a subsidiary of Ingram Industries. Print-ondemand publishers store books electronically and can print single copies of hard-to-find
books - or even individual chapters. Previously, publishers believed that unless a book
could sell at least 1,000 copies, printing it wouldn't be profitable. Print-on-demand makes
it profitable at 250.
So, effectively what Barnes & Noble is doing is integrating backwards to gain as much
control on the distribution channel as it possibly can and therefore reduce the risk of
disintermediation. B&N perhaps envisions a channel that looks like the following:
Publishers
Ingram
B&N
B&N.com
Consumers
79
With such a grip on the distribution channel, it appears that Barnes & Noble is positioned
well to compete in both 'bricks-and-mortar' and online markets. However, with so much
investment in retail outlets, Barnes & Noble may never be able to achieve return on assets
comparable to Internet-only sellers like Amazon.com.
Though the book industry may eventually evolve into a multiple channel structure (i.e.
both retail and Internet exist), it is clear that the retail channel will suffer major setbacks
because of the higher efficiency of the cyber channel.
6.2.2 Computers:
The computer industry is a $500 billion industry growing at more than 20% per year. The
PC segment in this industry is about $67 billion and growing at 30% per year. Dell
Computers (www.dell.com) has been extremely successful in selling computers on the
Net and expects to get more than 50% of its revenues by year 2000 from online sales
(Inter@ctive Week Online, 1998). Eventually, Dell is also expecting more than 50% of
its sales to come from customers outside US. The key elements of Dell's strategy (San
Jose Mercury News, 1998) are:
e
Dell doesn't aim at first-time buyers. It targets selling directly to customers who are
computer-savvy and know what they want.
e
For Dell, being direct isn't just a matter of taking orders on the phone or a Web site.
It's an organic part of the operation. For example, Dell is planning to take the directcontact notion considerably further by linking customers' online feedback about
quality and reliability directly with its suppliers' computer systems.
As a result of this strategy, Dell has historically sold about two thirds of its machines to
big business and government. It has set up more than 8000 "premier pages" on the Dell
web site to customize the purchase process for its large customers. This translates into
huge savings for its customers by reducing the transaction cost of purchase. Ford, for
80
example, saved about $2 million in the procurement process (Inter@ctive Week Online,
1998).
On the other hand, Gateway (www.gateway.com), a company that follows a business
model similar to Dell, has historically concentrated on the home market (US News &
World Report, 1998). However, the two companies are now trying to steal each other's
market by expanding their target markets.
Companies like Dell and Gateway have been very successful in selling direct because of
some peculiarities of the computer industry. The obsolescence rate in the industry is
extremely high, with inventory depreciating at a harrowing rate of 1% to 2% per week
(Money, 1999). As a result, the longer the channel, the higher is the inventory cost. Such
inefficiencies overwhelmed Compaq (www.compaq.com) in early 1998, when its
inventory backlog crept up to nearly 10 weeks. The company had to slash prices to
reduce inventory down to three weeks, but is still nowhere near Dell's inventory of about
one week.
The other important factor has been the ability of these companies to offer a customized
product. Buyers can configure the computer system they want to buy on the web site.
Both Dell and Gateway, for example, give a wide configuration choice in terms of
hardware, software, memory, drives, financing and service & support options.
A review of the key parameters determining the channel structure for this industry reveals
that there is a high likelihood of total disintermediation, of the type portrayed in scenario
5 in earlier section, happening over a period of time. All of the following factors favor a
direct channel:
1. Customers generally require no assortment.
2. Product purchase is highly information intensive because of high degree of
technological activity in this industry and the wide variety of product configurations
possible while buying,
81
3. Retail is not so convenient and does not add much value to the consumers decision
making process.
4. Risk of purchase error is low because of established brand equity of most players in
the market.
5. Computers are high value items and UPSable. The cost of direct shipment to end
customer is therefore not very significant compared to the cost of the product.
Based on the above analysis, the decision flow chart for computers looks as follows:
y
A study by IDC (www.idc.com) has forecasted that by year 2001, there will be a major
shift to direct channel in the PC market. The study predicts an increase in direct sales
from about 28% in 1997 to about 34% in 2001. The fact that computers are perhaps the
82
best-suited product category for direct sales over the Net is also evident from the fact that
the revenue of 10 computer-only catalogers ($27 billion), including Dell and Gateway,
accounted for more than 45% of total catalog sales ($60 billion) in US in 1997.
Since computer purchase is such an information-intensive exercise, the flowchart also
suggests that there is a place in the market for information intermediaries. However, even
if the information intermediaries sell on the Net (as cybermediaries), they would not be
able to easily provide manufacturer's customized solutions to the buyers. This is seen on
the web sites of e-retailers like www.compusa.com who provide in-store configurations
of manufacturers like Compaq and HP, but custom-configured products only from its
own brand of AmericanPro and AmeriNote.
However, the key question is whether consumers will use such e-retailers for only
information search or also for buying on the Net. To explore this further, the prices of
various products offered by CompUSA are compared with the direct offerings from the
manufacturer (as on 4/3/99):
Product
CompUSA
Sony Vaio PCG- $1799.95, available
505TS Notebook
for backorder
Sony Vaio PCG838 PC Notebook
Sony Vaio PCVE518DS Desktop
Toshiba
Satellite
4025CDT
Notebook
Toshiba
Manufacturer
$1799.99
vaiodirect.sel.sony.co
m/
$2699.99
$2699.95, available
for shipment
$2299.97, available $2799.99
for shipment
$2099.95, available $2499.00 ESUP,
for shipment
Retail series
www.csd.toshiba.co
m
Tecra $2554.95, available $2699.00 ESUP
780CDM Notebook
Comments
Special price offer
(Xtreme buy)
Toshiba
sells
online
through
resellers only.
for backorder
HP Vectra VL, $1299.95, available $1363.00
Minitower
for shipment
www.buy.hp.com
HP Omnibook
Special price offer
by CompUSA
No
common
offerings.
From the above table, it is clear that the reseller (CompUSA) price is generally less or
equal to the manufacturer's price. While Toshiba allows custom configuration of products
83
online, when it comes to buying online, the user is redirected to the resellers' web sites.
HP on the other hand is generally selling products through its 'commerce center' that are
not being offered through resellers. It is apparent that the manufacturers are torn between
trying to participate in the growing Internet sales and avoiding channel conflict. With
increasing downward pressure on prices in the computer industry, it may not be long
before manufacturers start offering the full range of products at competitive prices on
their web sites, competing directly with their own channel partners. The channel is
currently evolving as follows:
Manufacturers
Distributors
Resellers
Consumers
Cybermediaries
The channel conflict arising in the industry is primarily due to the reason that everyone:
manufacturers, distributors and resellers wants to occupy the space of cybermediaries.
And in the long run, there may not be enough space for too many players in this area. For
the time being however, every player in the channel is vying for the cyberspace;
leveraging whatever possible relationships they can create or manage in the marketplace.
For instance, Internet retailer www.buy.com purchases computers from distributor
Ingram Micro Inc. thereby disintermediating the retailers but leveraging the distributor
infrastructure (WSJ Interactive, 1999). Similarly, www.oisale.com has a supply
agreement with Tech data Corp., a PC distributor with $12 billion in revenues.
However, the manufacturers are clearly in the best position to sell directly to buyers, and
therefore it appears that the channel will gradually evolve into the following structure:
Manufacturers
Consumers
Value-added
-"
Resellers
Infomediaries
'
84
The existing resellers who already have large investments in brick-and-mortar outlets will
therefore migrate from being just resellers to being value-added resellers, also providing
information services to buyers in the form of product/ merchant/ price search. For
example, computer distributor MicroAge Inc. transformed itself from a supplier-focussed
company to one whose sights are set on customer-centered value-added services
(Software Magazine, 1997)
The value-added intermediaries may also be independent players that provide only
service support and not participate in the sales transactions. For example, third party
vendors like Unisys Corp. and Wang Global provide virtually all Dell warranty services
through its PowerEdge services.
6.3 Limitations of exploratory analysis:
The analysis done in Section 6.1 and 6.2 is only exploratory in nature and needs to be
supported by empirical research. It also does not take into account the variance in needs
of different consumers that may be identifiable by market segmentation. For instance, the
computer industry can be segmented into high-end and low-end segments that clearly
have different needs and therefore may be served best by different channels. For high-end
(generally custom configured) computers, a direct channel supported by build-to-order
strategy may be desirable, while for low-end computers, an indirect channel may be more
desirable. Even within the same segment, there would be variance in consumer needs and
behavior. For instance, some consumers may find retail purchase inconvenient while
others may actually find it enjoyable. Similarly, for some consumers, the risk of buying
without physical inspection may be insignificant while for other consumers, it may be
significant enough to dissuade them from buying on the Net. On account of the above
reasons, the conclusions derived from the exploratory analysis are necessarily weak and
need to be supported by adequate market research. The conclusions are also weakened by
the fact that it is too early in the diffusion cycle of the Internet, and therefore current state
of Internet commerce may not be representative of the long-run equilibrium.
85
7
Conclusion:
7.1 Thesis findings:
This thesis explores the impact of the Internet on the structure and form of intermediaries
and analyzes the sectoral differences in disintermediation. Eight critical variables that
affect the structure of distribution channels are identified and analyzed in the context of
the Internet's capability to provide a low cost information and transaction medium for
sellers and buyers. The relationship between these variables and channel structure is
developed into a flowchart that is used to analyze five different disintermediation
scenarios.
These five scenarios suggest that the notion of complete disintermediation, i.e.
elimination of all types of middlemen from the distribution channel is farfetched and
misplaced. However, this does not imply that the Internet will have no significant effect
on intermediaries. On the contrary, Internet is likely to reshape the role played by
intermediaries and therefore new forms of intermediaries and distribution channels will
emerge. Traditional intermediaries will transform into or will be complemented by three
distinct types of intermediaries:
1. Information intermediaries, who will primarily provide information and transaction
services to the consumers.
2. Logistics intermediaries, who will provide logistics services between the sellers and
buyers.
3. Value-added intermediaries, who will provide services related to trust and service
support required for the cyber markets to work.
Although the transient stage in the evolution of this channel transformation will be
determined by the channel conflict and the race to occupy the cyberspace, in the long run
the channel structure may be expected to be determined primarily by logistics and
86
marketing considerations. Hence, in the long run, basically three different scenarios may
emerge:
1. The retailer, who will have brick-and-mortar outlets as well as cyber-outlet, handles
the transaction and last-leg logistics.
2. The wholesaler, who will have distribution centers as well as cyber-outlets, handles
the transactions and last-leg logistics.
3. The manufacturer will directly handle the transactions and logistics (using 3PL
services).
7.2 Future research:
This thesis provides a framework that can be used as a starting point for further research
on understanding distribution channels and integrating the different approaches found in
the literature. Research on marketing/ distribution channels requires an interdisciplinary
approach that is generally found lacking in the literature.
To establish the hypothesis developed in this thesis, it will be necessary to initiate
empirical research for different industries and segments supported by detailed case
studies on organization entities in the channel in terms of how their strategies are
evolving in view of the flux created by technologies such as the Internet. It will be useful
to expand the perspective to include the manufacturer's long term objectives besides
consumer needs and buying behavior. For instance, it is important to understand the cost
tradeoffs in direct vs. intermediated channels, in terms of distribution and manufacturing
costs. As markets move towards one-to-one marketing enabled by the Internet, it is
possible that manufacturing costs may go up in the long run because of ever increasing
expectations of consumers in terms of customization and delivery time.
This thesis also does not consider the transient dynamics of evolving channels. Issues
such as channel conflict and diffusion of new technologies such as the Internet need to be
studied in greater detail to understand why the existing channel structure may be different
from the normative channel structure discussed in this thesis. Use of System Dynamics
87
simulation tools can help in understanding the interplay between various parameters that
may otherwise be considered as 'independent'
in a typical econometric model of
marketing channels. A diffusion model such as the Bass diffusion model can possibly be
applied to the framework developed in this thesis to understand why certain consumer
segments will prefer certain channels and how it may change over time.
Finally, this thesis has primarily focussed on the impact of the Internet on the number of
echelons in a distribution channel, ignoring to a large extent the impact on the number of
intermediaries in a specific echelon (distribution intensity) or the exclusivity of the
distribution channel. Further research is therefore required to understand in a more
comprehensive way the impact of the Internet on these characteristics of distribution
channels.
88
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