A new breed of intermediary is taking advantage of the economics of information. One of them may already be at work in your market, insinuated between you and your customers.

New entrants such as Industry.Net, IBEX, and Auto-By-Tel are using electronic networks to jump into the value chain in markets from software to industrial goods. The Internet’s World Wide Web, along with the many private networks now emerging, allows these intermediaries to match buyers with sellers and deliver products and services at much lower cost and asset intensity than would be possible within a physical value chain.

Opportunities for buyers, sellers, and new intermediaries to create value in electronic channels are by no means limited to start-ups. Established companies are also moving to capitalize on the economic benefits and marketing reach of e-commerce technologies. Banks are moving to shift their customers to electronic channels - and cross-marketing related financial services such as brokerage and travel along the way. Retailers including Wal-Mart and Kmart have announced on-line sales programs. Some of these shifts are being driven by the entrance of new intermediaries; others are designed to discourage new entrants.

These moves indicate that electronic commerce - defined as the electronic exchange of information, goods, services, and payments (Exhibit 1) - has finally come of age.

Companies still mulling over technological issues - like how to establish a web site - and wondering when or if to include electronic commerce in their plans, may be missing opportunities or threats that are now emerging. Just about any industry is a fertile field for benefits to be captured or for new intermediaries to take hold. More than opportunity cost is involved: for established players in such industries as financial services, electronics (including software), publishing, industrial goods, entertainment, healthcare, and retailing, electronic commerce holds the potential to place revenue streams at risk.

In payment systems alone, a portion of the $33 billion in transaction revenues may be up for grabs as payments are transferred from the physical to the electronic value chain. We estimate that for every percentage point shift to electronic payments, anywhere from $50 million to $300 million in payments revenues, could be captured by payments processors - companies that may or may not be the existing financial institutions who currently capture those revenues and the related spread and float income.

Established players of all stripes are often at a distinct disadvantage when it comes to competing on these new terms. Their existing products, culture, business practices, channels, and customers can all militate against seizing new opportunities - particularly if these involve cannibalizing current revenue streams. But they can compete in electronic commerce provided they have a solid understanding of what it is, how new intermediaries are using it to reduce costs and to grow revenues, and what structural changes will arise as their industry migrates from the physical to the electronic value chain.

E-commerce comes of age

Electronic commerce used to be the preserve of large companies that could afford to build or lease the necessary proprietary networks. Applications were mostly limited to EDI (electronic data interchange) and EFT (electronic funds transfer). The computer systems required were generally mainframes, with complex, purpose-specific software and massive systems integration requirements. Today, however, users of all stripes need only a PC and a phone line to take advantage of the growing number of public and private networks that use standard protocols such as TCP/IP.

This "scalability" puts small businesses on an equal footing with large corporations. For departments and working groups in big companies, it means no longer having to monopolize the entire MIS department (or join its obscenely long queues) in order to establish direct links with customers and suppliers. And as PCs penetrate further into the home, it is enabling the development of new business-to-consumer applications.

This kind of democratization signals that after years of hype, electronic commerce has finally come of age. Other evidence includes:

• The explosion in commercial World Wide Web sites - from 370 in June 1994 to 50,000 in January 1996.
• Rising subscriptions to on-line services - up 15 percent during the rst quarter of 1996, to over 13 million in the US alone.
• The continuing growth of EDI, estimated at 25 to 40 percent annually
• The intensity of trac and transactions over the Internet World Wide Web (estimated at under $500 million at best, but growing steadily).

To fuel this boom, several underlying forces have come together at once: the wider availability of open router-based networks like the Internet, offering inexpensive bandwidth; easier access to these networks provided by point-and-click web browsers; multimedia development tools that can be used to create rich content; the emergence of open standards in development tools and at the network protocol level (for instance, TCP/IP) that are making it more cost-effective for software developers and other technology providers to create interoperable products; the growth in support services (such as web business design, hosting, and gateway services) that help accelerate adoption; and the development of critical processes (ordering, billing, payment, and so on) that are in place now or soon will be. Perhaps most important, users’ inhibitions about using e-commerce are rapidly being overcome, thanks to innovative approaches like AT&T’s guarantee of credit-card purchases over the Internet.

This gathering momentum is creating a virtuous cycle of growth (see Exhibit 2). Continuing advances in network infrastructures and computing devices are allowing web site designers, web hosts, and ancillary support businesses to supply the overlay technologies and services that enable the proliferation of electronic marketplaces. Together, these independent developments are accelerating the expansion of electronic commerce.

Early movers in this rapidly evolving world can get ahead by attracting businesses to new on-line marketplaces, by determining the range of products and services these marketplaces offer, by setting the rules of interaction, and by reserving value-added positions for themselves.¹ In the auto and high-tech manufacturing industries, for example, the success of new intermediaries that provide an electronic link for product presentation, lead generation, negotiation, accreditation, and (eventually) transaction processing is already being felt in the sales and marketing departments of major companies.

If you are a manufacturer for which these on-line intermediaries are streamlining an otherwise unwieldy and costly distribution system, their effect can be positive. But if you are one of the traditional players in that distribution system, their presence may be much less welcome.

Opportunities for impact

The promise of electronic commerce rests on the overwhelming benefits of networks. Corporate data networks confer advantages both within organizations, where they enable companies to link internal work groups for better, faster decision making, and in external relationships, where they help businesses to expand their sales and marketing capabilities and reach new markets. We have identified four areas in which e-commerce can have a particularly dramatic impact:

Reshaping customer relationships

Much has been written about the opportunity to gather customer data through business-to-consumer electronic networks, and thereby not only improve customer service but also begin to "lock in" particular segments by offering them more finely targeted products and services. Much less has been said, however, about the power of networks to destabilize relationships between vendors and suppliers in business-to-business markets. Access to a fuller range of information about product availability and pricing can shift power away from established relationships. The result may be reduced price to the vendor.

The way a number of companies, like NEC and others, have decided to open up their proprietary purchasing and materials databases illustrates precisely this point. For example, NEC has opened its centralized purchasing control network that compares information from buyers in each division to identify the best prices and terms from each supplier. The new system will allow input via public networks from an unlimited number of component vendors and public databases, effectively leveling the playing field for NEC’s suppliers. Traditional suppliers will no longer be able to rely on their access to buyers in order to remain the source of choice. For component companies that were not part of the original closed network, a whole new set of relationships becomes possible.

Electronic intermediation

This is really two separate opportunities: for an established player to reinvent its market, and for a new entrant to disintermediate existing relationships.

Asian industrial goods manufacturers exemplify the first kind of opportunity. Long active in export markets, and with a deep understanding of the economics of physical channels, they are now recognizing the benefits of a virtual trading network that could reduce their selling and procurement costs quite significantly. Caught in the 1991-92 economic downturn in Japan, these manufacturers were searching for ways to stimulate sales in their home market. So they began buying up used machines and reselling them in the developing countries of Southeast Asia that could not yet afford new equipment. Buying and selling were conducted through a complex multi-tiered structure of brokers.

With the launch of a new virtual market, however, prospective buyers would be able, in return for an access fee, to log on and obtain basic make, model, and price information on machines offered by a range of manufacturers. They would be able to examine the title for authenticity to make sure they were not buying a stolen machine, and check the condition of the equipment by clicking on a series of close-up pictures. For an additional fee, they would be able to request information about loans, make delivery arrangements, and obtain insurance. At the same time, equipment sellers would be able to run credit checks on prospective buyers.

Various ancillary services, such as credit, delivery, and insurance, could be offered on line by third parties. Not only would the system streamline the complex brokerage structure, but it would allow buyers to cut their inventories and reduce sales, goods, and administration. Even after paying access fees and higher manufacturers’ margins, buyers could come out ahead by using electronic channels. This new marketplace would naturally threaten the brokers on both sides, which would have to find innovative new roles to play - in support services, for example.

For an illustration of the second type of opportunity for electronic intermediation, consider the potential of small, fast-moving companies like Industry.Net to shape markets by facilitating communications, negotiations, and eventually - when secure process software becomes available - transactions between sellers and buyers. Industry.Net is an electronic marketplace, originally specializing in high-tech manufacturing equipment but now offering the same menu of business-to-business communications and transactions support to a range of related product areas. Having begun as a business directory, it used the information it had built up about customers and suppliers to evolve into an electronic "mall" providing electronic storefronts, product descriptions, job classifieds, directories, and so on to over 4,500 members. With the potential to reduce participants’ sales and marketing costs and also to extend their market reach, Industry.Net enables smaller companies to establish relationships with far-flung customers and suppliers that were previously outside their grasp. According to members, the service has already helped streamline the lead generation process and speed the dissemination of product information.

The role Industry.Net will ultimately play as market facilitator has yet to be fully defined. The large number of companies registering as participants, combined with current trends in revenue growth (estimated as 200 percent to date from a small base in 1995), suggests that it may succeed in building business-to-business communities of interest. As early as summer 1995, it was searching for process technology to allow members to place and pay for orders while on line. Such a transaction capability would not only help lock in customers, but also position Industry.Net to extract usage or transaction fees on top of the subscription revenues it currently derives.

A second small start-up, this time on a so-called "private Internet," (closed membership TCP/IP network) may stimulate restructuring in part of the real estate business. A new closed network, TitleLink, is electronically connecting the many parties to a real estate transaction - agencies, banks, insurance companies, title companies, lawyers, sellers, and buyers - so as to streamline title issuance and cut processing time and costs. TitleLink aims to supersede the cumbersome communications (loan applications, credit reports, land appraisals, and so on) that are usually conducted via fax, telephone, and courier, often taking up to three months to complete.

The network is designed as a membership system, with TitleLink providing workflow and security management for transactions in return for a fee of $75 per month and a charge of 3 cents per minute of use. The benefits to members are easy to imagine. Not only will TitleLink make doing business cheaper, but it will also confer a definite competitive advantage over players that are not part of the network.

However, the closed nature of this network does present risks for TitleLink. While a private network can provide its members with valuable management and security services not yet available on the Internet or other open networks, there is always a danger that a more widely accessible competing marketplace will develop. The key to sustaining advantage will be to attract and lock in a critical mass of participants early in the game. Recognizing this, TitleLink has already begun developing an Internet version.

Improving core business processes

Electronic commerce eliminates barriers of time and distance. Businesses can tap resources in distant locations and perform functions such as software development wherever the most skilled and least costly talent resides, rather than where their offices or management happen to be located. Equally, they can outsource parts of their business system to better or less expensive providers. With the emergence of distributed, low-cost networks like the Internet, it is becoming cheaper to communicate between enterprises than to develop or maintain certain skills in-house. Web server operations are one activity where outsourcing to third-party providers (say, telcos or hosting services such as Open Market) may be the right approach for many companies.

Electronic commerce is accelerating the unbundling of business systems, allowing companies to focus on the most promising pieces of what were traditionally vertically integrated businesses. With the availability of content sources on line, for example, local newspapers can concentrate on packaging content for their particular geographic market, focusing on local news while accessing networked sources for national and international news.

Reaching new segments and markets

Electronic channels offer companies the opportunity to gain incremental revenues by acquiring new customer segments or locking in current buyers. Wal-Mart’s recent agreement with Microsoft, for example, is aimed at developing an on-line retailing service capable both of reaching potential customers who do not buy from their stores and of getting deeper into the wallets of current consumers by providing them with a broader range of products.

Wal-Mart is no stranger to using networks as a competitive advantage. By the early 1990s, it had already oriented its business around networks linking 20 to 30 automated distribution centers to 4,000 suppliers and some 2,400 stores. When the retail outlets began inputting product sales information automatically, the distribution centers were able to hold and ship goods more efficiently. As a result, Wal-Mart achieved much lower distribution costs than its competitors.

Its recent networking initiative has more of an external focus. Together with Microsoft - which is using this effort as a beta test for three products, the Merchant Server, the Merchant Workbench, and the Shopper User Interface - Wal-Mart will offer a broader range of products to customers who are too busy to shop in its conventional stores, to those who don’t live near a store, and to those who want upmarket products. The extra convenience of on-line shopping may also encourage existing customers to spend more. Eventually, the entire inventory of current store items will be offered.

The initiative also allows Wal-Mart to participate in customer data tracking and billing and the potential to extract additional value from its access to and management of scarce information. Meanwhile, Microsoft gains experience that will help it offer attractive services and tools to other retailers with product mixes targeted at on-line consumers.

The challenge for incumbents

As e-commerce spreads through an industry, those that understand and use the economics of the electronic marketplace will gain competitive advantage over those that do not. The rise of intermediaries exploiting electronic channels to circumvent (and in some cases replace) physical channels represents a wake-up call for incumbent businesses. New entrants are more visible in some markets than others, but the pressure is on established players everywhere to think through the competitive implications for them. Some will need to adopt radically different practices if they are to compete for the emerging value-added roles being targeted by new entrants. The key to success will be to leverage their franchise into the electronic marketplace.

This will not be easy. For most incumbents, e-commerce will require broad changes in organizational approach and structure, as well as in skills, mindset, human resources, and measures of economic success. Many will have to cannibalize existing businesses or channels and risk demotivating the traditional organization while building the new.

As is usually the case with dramatic change programs, a small core of people will be critical to the effort. However, they may have to be recruited from outside rather than nurtured as home-grown champions. Attracting them away from innovative start-ups will call for incentive systems that will appeal to what might be called their "dream quotient," as well as taking into account the high demand for capable people with experience in electronic commerce. In other words, compensation packages must allow for the possibility of achieving fame as well as fortune.

For most traditional organizations, structuring such packages will probably entail setting up an independent business unit for e-commerce, or redrawing existing organizational lines. Even companies that succeed in carving out an organization that propels innovation will have to be careful not to stifle the venture by trying to convert it back into a traditional model in the longer term.

An organizational tolerance for risk will be vital. Emphasizing iterative learning will help build the necessary skills and mindsets quickly. Long-term strategic plans relying on elaborate management processes are unlikely to prevail against nimble new entrants unencumbered by past decisions. As the CEO of one high-flying Internet-based business stated, "We are kind of making up the business model as we go."

Above all, what incumbents need to power the shift toward e-commerce is courage. Success will involve piloting new approaches, mastering new technologies, challenging conventional market definitions, surviving an initial period of low revenues, and perhaps cannibalizing core businesses. But the potential rewards are great: a new platform and set of tools for competing in a new and dynamic marketplace.