The New Economicsof E-Commerce:

Interpreting the Marketplace

Robert J. KauffmanCarlson School of Management

University of Minnesota

Based on (1) R. J. Kauffman and E. A. Walden,“Economics and Electronic Commerce: Survey and Directions for Research,”International Journal of Electronic Commerce, 5, 4 (June 2001), 4-115, (2) Q. Dai and R. J. Kauffman, “Business Models forInternet-Based E-Procurement and B2B Electronic Markets: An Exploratory Study, in Proceedings of the 34th Hawaii InternationalConference on Systems Science, Maui, HI, January 2001, IEEE Computer Society Press, Los Alamitos, CA, 2001, (3) A. M. Chircu andR. J. Kauffman, “Reintermediation Strategies in Business-to-Business Electronic Commerce,” International Journal of ElectronicCommerce, 4, 4 (Summer 2000), 7-42, and (4) A. M. Chircu and R. J. Kauffman, “Strategies for Internet Middlemen in theIntermediation / Disintermediation / Reintermediation Cycle. Electronic Markets, 9, 2 (February 1999), 109-117.

Speaker’s BiographyRobert J. Kauffman is Professor and Department Chair of Information and Decision Sciences at theCarlson School of Management, University of Minnesota.  His current research interests center on IT andorganizational strategy, electronic commerce, adoption and diffusion of technology, the economics ofinformation systems, applications of IT in financial services, and measuring the value of IT investments.  Hereceived a B.A. from the University of Colorado, Boulder, an M.A. from Cornell University, and an M.S. andPh.D. from the Graduate School of Industry Administration, Carnegie Mellon University.  Rob has heldfaculty positions at New York University and the University of Rochester. His research appears inInformation Systems Research, MIS Quarterly, Decision Science, Communications of the ACM, Journal ofManagement Information Systems, Journal of the Association of Information Systems, IEEE Transactions onSoftware Engineering, and International Journal of Electronic Commerce. 

He has twice co-chaired the annual Workshop on Information Systems and Economics (WISE) Rob alsoacts as an associate editor for Management Science, International Journal of Electronic Commerce,International Journal of Intelligent Systems in Accounting, Finance and Management, Journal ofManagement Information Systems, and the newly- announced Information Systems and E-BusinessManagement. His newest research article, due out in Organization Science in November/December 2001, ison reservation system competition in the airline industry. He also completed a special issue of the Journalof Management Information Systems on “Economics, Electronic Commerce and Organizational Strategy,”which is due out in Fall 2001. This follows up a prior issue of Communications of the ACM that he edited inAugust 1998 on “Economics and Information Systems.” In his spare time, Rob likes to travel, sail smallboats, and play the piano. He lives with his wife, Jean, and daughter, Lauren, in Bloomington, Minnesota.

‘The EBay of Blank … ?’

n Internet IPOs: Wit Capitaln On-line stock trading: Charles Schwabn Electronics retailing: Buy.comn Books: Amazon.comn B2B E-Markets: E-Steel.com

But the opportunities aren’t like they used to be – at leastwhen venture capital is required.

Driving Principles inElectronic Commerce?

n Spacen Timen Valuen Efficiencyn Markets

n Transactionsn Impulsen Growthn Mattern People

Ask: What principles can be leveraged for competitive advantage in your context?

Source: Business 2.0, http://www.business2.com/magazine/2000/03/20735.htm

Why Examine E-Commercefrom Economics Perspective?n Depth and breadth of the applicable

theoryn Maturity, rigor and precision of the

analytical techniquesn Natural emphasis on decisionmakers,

products, processes, firms, markets andaggregate economic behavior

n Power of econometric methods tohandle large-scale data analysis

MACRO

PRODUCTS

TECHNOLOGY

MARKETS

BUSINESS PROCESSES

EN

AB

LE

SENABLES

DEFINE DEFINE

USE USE

ENABLESA

GG

RE

GA

TE

ANALYSIS LEVELS

ACTORS

AGGREGATED

DISAGGREGATED

VALUE MAKERS VALUE TAKERS

CONSUMERS --SocietyGroupsIndividuals

FIRMS --CompetitorsAlliancesIndustries

MACRO

PRODUCTS

TECHNOLOGY

MARKETS

BUSINESS PROCESSES

EN

AB

LE

SENABLES

DEFINE DEFINE

USE USE

ENABLESA

GG

RE

GA

TE

ANALYSIS LEVELS

ACTORS

AGGREGATED

DISAGGREGATED

VALUE MAKERS VALUE TAKERS

CONSUMERS --SocietyGroupsIndividuals

FIRMS --CompetitorsAlliancesIndustries

A Framework forE-Commerce Research

Applicable Economic Theories

Let’s Talk About …

n I. Technologiesn II. Business processesn III. Electronic markets and e-intermediationn IV. Firm strategies in the marketplace

… all through the interpretative lens of economic theory and thinking

I. Technologies

Initial Wordsfor the Network-Wise

“Almost any decision about a given technicalsolution will be risky, until it becomes clearthan there is sufficient installed base for thesolution to become cost-effective and value-

effective as a network.”n Standards combat among e-commerce solution

providers complicate matters

Contested Groundn There are many domains in e-commerce in

which standards combat is occurring:n DotCom and e-business infrastructuresn Web-based travel reservation systemsn Internet-based B2B procurement markets

n E-billing is a good example -- no longer arevolution, but an evolution that we are seeingin the marketplace ... and it’s focused on IT

Integrion’s Solution Sounded Great

Owners included:• B of A• Citibank• and more banks• IBM

In theory, atleast ………..

But Who Will Win in E-Billing?

Microsoft is behind Transpoint too. What does this tell us?And so is Citibank … Real options, here, don’t you think?Nobody knew how this combat would come out.

Network Externalities Tell Youn The value of a technology standard

increases with the number of adoptersn Externalities grow over time

Network Value

# of Adopters

Highest Attainable Value

A

B

CHow will we knowwhat the valuetrajectory will be?

Time ?

Amidst This Standards Combatn Senior managers must think about IT

investments consistent with thevalue trajectory fornetwork externalities

n Don’t want to get on thewrong “bandwagon”

n So waiting has “real optionvalue”

Tap Into Installed Basen Larger network installed bases are consistent

with higher valuation and earlier corporateadoption of technological innovations

n Installed base: examples --n number of vendors in an e-billing networkn number of search engine usersn number of firms using XMLn number of buyers/sellers in an e-auction

But Timing is aBig Gamble

n Whom do we bet on?n Banks?n Consolidators?n Internet portals?n Software solution

vendors?n Translation: Who’s in the position to

generate the greatest externalities soon?

Seek Out “Spatial” Externalities, Too

eBay’s recent alliance with AutoTrader.Com is a good casein point: excellent externality growth, but regional focus.

Be Market Savvy on Standards

"Take advantage of the wisdom of themarket in gauging the value ofstandards; markets, even if they arewrong sometimes, are usually notwrong for long."

II. Business Processes

IT Used to Mass Customizein E-Commerce

n The product:n physical goods and

information goodsn create unique

product bundles

n The sellingprocess:n one-on-one

marketing with ITn create unique

value propositionsby segment

IT Used to SelectivelyCommoditize Products

to Create Liquidity

A trusted third-partymade all the differencein enhancing transactabilityof used cars in this e-market

IT Used for Product Rebundling

n Natural market re-segmentationbased on consumer preferences

n “Death spiral” and “adverseselection”

n Product and service, or both?

Leverage the unique capabilitiesof the firm with IT

Add Agents to the Processn Everything we sell is going to

the Internet, where businessand retail customers can easilycompare prices, service

n Ask: Are your “agents”working for you?

III. Electronic Markets and E-Intermediation

Operational Efficiency --An Intermediary Issue

n Reduce your costs byengaging the “right” kinds ofmiddlemenn B2C: infomediariesn B2B: e-procurement exchanges

n Ask: How can we provideaggregation, buying power,matching and businessintelligence? And more?

Traditional Industry ValueChain -- Retail Example

Producer Wholesaler Retailer Consumer

Note: Example based on Benjamin, R., and Wigand, R. "Electronic Markets and Virtual Value Chains on theInformation Superhighway," Sloan Management Review, 36, 2, Winter 1995, pp. 62-72.

n Ask: Are the value chain costs acceptable?

Wholesaler Retailer

Wholesaler

Identify Your AlternativeIndustry Value Chains

Producer Wholesaler Retailer Consumer

Producer Retailer Consumer

Producer Consumer

Cost: $52.72

Cost: $41.34

Cost: $20.45

Partial Value Chain Disintermediation

Traditional Value Chain

Full Value Chain Disintermediation

X

X X

Source: Jupiter Communications, “US Business to Business Trade Projections,” September 2000.

We are here

Models for Trade Between Buyers and Sellers, 1997-2003

Source: Jupiter Communications, “US Business to Business Trade Projections,” September 2000

B2B Procurement Markets

n Support market functions and mgmt requirementsn Provide technology infrastructures, business modelsn Function as “technology adapters” in marketplace

Technology Adapters: - Integrators - Standards providers - Outsourcing vendors

Basic Market Functions: - Aggregation - Matching - Facilitation

Management Needs: - Market intelligence - Business relationships - Business processes

Source: Dai and Kauffman (2001)

E-Market Function: Aggregationn Private, buyer-

specific e-catalogingn Pre-qualified

suppliersn Prices are negotiated

offlinen System integration

and connectivity isimportant

n Schlumberger, Inc.,and CommerceOne

n Public, buyer-neutrale-catalogingn Adopted for

purchases in smalllot quantities

n Demand is of lowpredictability andhigh variety

n Low price volatilityn SciQuest.com

Source: www.SciQuest.com

SciQuest.com – Public E-Catalog§ SciQuest.com aggregates product catalogs for pharmaceutical, chemical and biotechnology industries.

§ Lists 600 suppliers, and more than 1 million products.

§ Buyers can search and shop among all catalogs.

A Net Market

E-Market Function: Matching

n Private negotiationmechanismn Preselect

participants for bidsn Used for purchasing

direct goods in largequantities

n e-Steel.com

n Public biddingmechanismn Open bidsn Especially suitable

for exchangeexcess capacitiesand inventories

n FastParts.com

Public Bidding: FastParts.comn To serve procurement

professionals with “excessinventories on cancelled jobsand inventory shortages forunforecasted orders”.

n In SOLD!Auction, sellerspost offers to all memberswho bid against each otherin an anonymous context.

Source: www.FastParts.com

Dynamic Trading Processes: Pradium

E-Market Function: Facilitation

n Online transaction settlement: Net marketmakers are partnering with financialinstitutions and transportation providers tooffer services for transaction settlement.

n Procurement expertise: General andindustry-specific purchasing expertise arevalue-adding services provided by onlinemarkets.

Online Financial Services

n Internet-based financial services: Electronicpayment, electronic invoicing, credit facilities,foreign exchange, wire transfer, and automaticclearinghouse.

n For example: Ariba ispartnering withAmerican Express andBank of America todevelop a line of B2Bonline financial service

Source: www.Ariba.com

Settlement for Deliveryn Delivery and logistics: Smooth information flow

among multiple players in the process of deliveryis the focus.

n E-markets specialized in delivery andtransportation become logistics providers forother e-markets.

n Example: Optimum-Logistics.com ispartnering withChemConnect.com

Source: www.ChemConnect.com

Expertise and Market Intelligence

n Procurement expertise is built into tools for costcalculation.n Example: An online bond market, Axess.com provides

analytic and advanced modeling capabilities to helpfixed income securities investors trade their portfolios

n Market intelligence is derived from integrateddata of sales and transactionsn Example: MuniCenter.com, another bond e-market,

acts as an information portal for fixed incomesecurities investors, too

Expertise, connections

Market intelligence

Online Business Process Support:Streamline Workflow

n Workflow management: In document orinformation-intensive industries, business modelsare built to streamline business processes.

Source: www.ChannelPoint.com

n ChannelPoint“streamline[s] andautomate[s] theinsurancedistribution process”

E-Markets Function As Adapters

n E-markets connect buyers and sellers; formnetworks of participating firms.

n Network externalities – the value of an onlinemarket increases as more firms join it, attractingfurther more participants.

n Compatibility between different technologiespromotes network adoption.

n Adapters set up interfaces between differenttechnologies to enable at least partialcompatibility.

IV. Firm Strategy in the Market

What You Can Do …

n Face it: You may not be able to do it allon your own, if you haven’t been earlyto market for e-business opportunities

n Partner for:n Contentn Accessn Application development

n License technology you needn Continuously innovate

Partner for Content

n Figure out a way to partner with an“aggregator” for selling products andservices in your industry: don’t letothers do it first!

n Competitive advantage sources:n You can customize and brand the contentn You can retain control over your customers’

transactions

Partnering for content atMicrosoft Expedia: providinglinks to vacation bookingengines

Partner for Access

n Work with an electronic intermediarythat provides services for other agentsinvolved in e-commercen B2B portal providers

n Competitive advantage sources:n You can try to partner with a leading B2B

portal provider with whom you or theintermediary has an exclusivity agreement

Partnering for access:eBay sponsors the adsof AutoTrader.com

Partner for ApplicationDevelopment

n Aggressively establish alliances withestablished e-commerce industryparticipants

n Sources of competitive advantage:n Gather the right combination of assets

(technological and industry-specificexpertise) in a way that is otherwise notpossible

Amex Travel Related Services’Recent Partnerships

n Microsoft, for online travel bookingn Portable, for expense mgmt

License Technologyn Find a competent provider from which

to buy the “right” technologyn Share in the profits result from

transactions that are referred to you byother web sites

n Sources of competitive advantage:n The technology is complex enough such

that it cannot be copied easilyn No industry standards are established yet

Technology Licensing at ITN.Com

Note: ITN.com is nowknown as GetThere.com

This presentation was prepared as the keynote address forthe Workshop on E-Commerce and Agricultural Markets,held at the Economic Research Service (ERS) of the UnitedStates Department of Agriculture in Washington, DC onMay 28-29. The author offers his thanks to ProfessorsTerry Roe and Hamid Mohtadi of the Applied EconomicsDepartment, University of Minnesota, for suggestions onthe contents. He also thanks his research colleagues atthe Carlson School of Management for all theencouragement they have offered over the years with mythinking and interpretation of developments in themarketplace and directions in e-commerce research.

Acknowledgements

Contact Information

Robert J. KauffmanProfessor and ChairDept. of Information and Decision SciencesCarlson School of ManagementUniversity of MinnesotaMinneapolis, MN 55455Email: rkauffman@csom.umn.eduTel: 612-624-8562Fax: 612-626-1316