Lecture 09

Electronic Business (MGT-485)

Recap – Lecture 08

• Models for mobile wireless technology • Framework for analyzing e-business models• E-marketspace Characteristics • Adding Value to Customers• Achieving Economic Viability • Achieving a critical mass of customers • Continuing to innovate and add value • Design for flexibility

Contents to Cover Today

• E-business economics– Towards perfect competition – Effect of internet on the competitive environment – Key economic characteristics of internet – Cost of production and distribution – Disintermediation and reintermediation – Economics of information – Connectivity and interactivity – Economies of scale – Economies of scope

Towards Perfect Competition

• Economics is concerned with the efficient allocation of resources.

• Perfect competition refers to a market where no individual buyer or seller can influence the market

• Perfect competition is a theoretical market structure based on a number of key assumptions. e.g.– There are many buyers and sellers;– There is freedom of entry into and exit from the market;– There is perfect mobility of the factors of production;– There is perfect knowledge of the market;– There is a homogeneous product.

Towards Perfect Competition

• Perfect competition describes an efficient market because it leaves no excess supply or demand of goods or services.

• In the real economy this rarely, if ever, happens. • Most markets fail to match supply with demand and, therefore,

operate at less than optimal efficiency.• There are numerous reasons why markets fail e.g.

– There may be a lack of information and knowledge pertaining to the supply of goods and services into a market;

– There may be excessive transaction costs (where the costs of making a transaction outweigh the benefits to consumers or suppliers)

– Transactions may be prevented by geographical distance between buyers and sellers;

– One seller may have greater economic power than others in the industry and can influence the market price.

The effect of the internet on the competitive environment• The internet has provided a mechanism for edging

markets closer to that of perfect competition. • Ease of access and lack of regulation means that

there are many buyers and sellers in the market. • Abundance of information on websites means that

buyers and sellers have access to greater market knowledge.

• Transacting via the internet ensures a more cost-effective way of matching supply and demand since there are no geographical or time constraints.

The effect of the internet on the competitive environment• One of the key characteristics of the e-business

environment is the ease of entry for firms. • The cost of entry and exit is low relative to traditional

industries, as firms do not require large sales teams, costly investment in infrastructure or high sunk costs in order to compete effectively.

• The nature of competition has been altered by the emergence of the internet.

• Both cost structures and the types of products and services being offered to customers differ from traditional industries.

The effect of the internet on the competitive environment• Reductions in cost can be achieved through smoothing

transactions between customers and suppliers and there are opportunities for customizing products to specific needs and building communities of buyers.

• The internet can change the relationship between buyers and sellers where switching costs play a crucial role in determining the balance of power.

• The reduction in transaction costs of searching for products or services makes comparisons of prices easier for customers and intensifies price competition among firms.

The effect of the internet on the competitive environment• Easy access to a huge array of information facilitates

consumers’ comparisons of prices and availability of products and services.

• The availability of market information contrasts with traditional markets where consumers are reliant on firms to provide them with such information.

• Conventional wisdom has it that this leads firms to compete more on price because of the absence of significant search costs.

• The bargaining power lies with the customer.

Key economic characteristics of the internet• Classical economic theory views information as a resource to

reduce uncertainty. • However, the development of the internet has led to increasing

emphasis on information as a productive element and a product. • Economic analysis of information as an asset should view it from

both the demand and supply sides. • Demand in the form of customers and businesses seeking

information on products and services, and supply side in the form of businesses providing information to customers and other businesses.

• On the demand side, the internet can be used as a means of accessing information about organizations and the products and services they sell.

Key economic characteristics of the internet• Customers usually access the website, scan the

range of products available, perhaps compare prices on other websites, and then make a decision on whether to buy or not.

• The internet helps smooth the transaction process. • Once an offer to buy has been received by an online

business the process of distribution takes place and the physical product is delivered to the customer.

• Inspection of the goods can only be done visually via the website.

Cost of production and distribution• The internet can help to reduce production and

distribution costs and make firms operate more efficiently.

• Market information on customers and logistics information gathered from suppliers, distributors and manufacturers form the basis for improving efficiency.

• The cost of marketing and advertising can be reduced using customer information effectively.

• Information on customer segments, the types of products demanded, trends in tastes and fashions, etc. form the basis for a more targeted marketing effort.

Cost of production and distribution• The internet is an effective channel of

communication and a source of information storage and retrieval.

• These attributes can form the basis for potential cost savings in the internal operations of firms.

• Information on the supply of raw materials, the capacity of manufacturing and orders from wholesalers, distributors and retailers all combine to enhance supply chain management.

Disintermediation and reintermediation

• Disintermediation refers to the removal of an intermediary somewhere along the supply chain of products and services from seller to consumer.

• Disintermediation has become a feature of the e-business and e-commerce environment because the internet facilitates greater communications between suppliers and customers.

• Disintermediation is a method of reducing the cost of bringing products and services to customers.

• Cost reduction is achieved by reducing the number of intermediaries in the supply chain.

• Firms can use this cost saving to offer lower prices compared to traditional markets.

• This can help build up a critical mass of customers, increase customer loyalty and create a competitive advantage

Disintermediation and reintermediation

• The savings from disintermediation can only be realized if the benefits of removing the intermediary outweigh the costs.

• Intermediaries along the supply chain add value as well as cost.

• Much will depend upon how dispensable the service they provide is to the customer.

• Disintermediation was a feature of the early development of e-commerce markets.

• The intermediaries, who had the traditional role as a conduit between buyer and seller, were being increasingly marginalized in the new economy.

• The role of intermediaries did not become obsolete.

Disintermediation and reintermediation

• Many intermediary firms have reinvented themselves and re-entered the supply chain by offering specialist knowledge or services for the online market. This process is referred to as ‘reintermediation’.

• Sometimes termed ‘infomediaries’, these firm deal on offer for their clients.

• This revives the specialist nature of their business and creates cost savings.

• The so-called ‘infomediaries’ transform raw data into valuable information, provide customer assistance or technology-based buying aids and increase market efficiency.

Economics of information• Information economics is distinctly different from the economics of

physical products. • Information is easily produced and can be distributed among a

large number of recipients including suppliers, customers and firms.

• The ease and scale of distribution does not diminish the value or quality of the product.

• Information is easily manipulated and altered to suit different needs of customers in different markets.

• Information that is in high demand, such as financial data, prices of stocks and shares and news items, constitutes high-value assets.

• Where traditional economic theory is concerned with scarcity of resources, the internet is characterized by an abundance of information.

Economics of information

• Information-driven products and services can be reproduced and distributed for near zero marginal cost (the cost of producing an additional unit).

• However, there may be diseconomies of scale associated with the abundance of information available to consumers (information overload)

• This adds a further reason for previously disintermediated firms re-emerging as information intermediaries, or ‘infomediaries’.

Economics of information

• The internet has had a profound effect on the economics of selling information, especially in the form of media products such as music, film and books.

• The economics of abundance already forms the basis of the business models of some of the internet’s most successful firms, including Amazon, e-Bay and Google.

Connectivity and interactivity

• In e-business and e-commerce, connectivity exists between information systems, and communication is two-way and in real-time.

• These characteristics enable real-time pricing, low cost of distribution of information and digital products, and a high level of interactivity.

• Interactivity makes the relationships between buyers and sellers richer and more intense

• The high growth rates in connectivity and interactivity have had a transforming effect on business.

• This is evident in relationships with customers, suppliers and partners; the pricing models used; the types of products and services offered; and the marketing and sales functions.

Economies of scale

• When production costs decrease with the number of units produced then firms benefit from economies of scale

• Firms benefit from economies of scale because the average cost of production declines as the number of units sold increases.

• Economies of scale can be derived from faster servers, more data storage availability or wider applications functionality.

Economies of scope• Economies of scope are the rate at which relationships are leveraged to

add value to customers. • In e-business firms can exploit market information gathered from

customers to provide added value across other markets • The internet can help achieve economies of scope in relation to

customers. • The more expertise any single firm has with respect to meeting the needs

of a particular individual customer, the greater that firm’s economies of scope will be for selling that individual a series of products both in terms of different products and repeat sales over a period of time

• Firms can also gain economies of scope by sharing common inputs over a range of activities or by collaborating with other firms in promoting or distributing products.

• The knowledge and know-how possessed by collaborating firms represents a shared input that can find a variety of end product applications.

Summary

• E-business economics– Towards perfect competition – Effect of internet on the competitive environment – Key economic characteristics of internet – Cost of production and distribution – Disintermediation and reintermediation – Economics of information – Connectivity and interactivity – Economies of scale – Economies of scope