Impacts of Electronic Commerce on Optimal Market Structure

Most observers would agree that the explanatory capabilities of current theories of electronic intermediation on the Internet fall short of having the desired power. Instead, the patchwork quilt of theoretical assertions, conflicting empirical results, and revealing case studies that characterize the existing literature point to the need for a new synthesis. This article makes an attempt to do just that by proposing an explanatory and predictive contingency model for intermediated and non-intermediated market structures. We distinguish between direct and intermediated markets, as well as traditional and electronic markets in a two-by-two classification grid allowing a number of industry examples to be typed. Explaining why the industry examples end up in those “buckets” required deeper reasoning, on the basis of a blend of existing and emerging theory, not all of which delivers the same predictions. For this reason, our proposed contingency model leverages a variety of elements of the existing theories and empirical findings (including transaction price, search cost, liquidity, trust, expertise, risk exposure and technological adaptation cost), which enable us to usefully interpret three illustrative mini-cases involving the airline ticket market, the used car market, and the antiques and collectibles market. Our findings provide preliminary support for contingency model as interpretative tool for management. _____________________________________________________________________________________ Acknowledgements. An earlier version of this article was submitted to and presented at the Infonomics/Merit Workshop on Digitisation of Commerce: e-Intermediation, International Institute of Infonomics, Maastricht Economic Research Institute on Innovation and Technology (MERIT), Maastricht, Netherlands, November 23-24, 2001. We thank the workshop coordinators and the participants for useful input. Forthcoming in T. Dunnewjik, H, Meijers, and L. Soete (ed.), The Economics of Electronic Intermediation (tentative title), New York: NY, Springer-Verlag, 2002. _____________________________________________________________________________________ INTRODUCTION: TOWARDS A NEW THEORY OF INTERMEDIATION A growing body of literature in the Information Systems (IS) field is concerned with how information technology (IT) reshapes organizations and markets (Bakos and Kemerer, 1992; Kauffman and Walden, 2001). In this work, we explore the impacts of a particular form of technological innovation – the technologies of electronic commerce – on the optimal market structure in which buyers and sellers prefer to transact. In a traditional market, buyers and sellers transact either directly, or through an intermediary, also called a broker or a middleman. One of the primary roles of an intermediary is to connect buyers and suppliers more efficiently than they can do it themselves in a direct market structure. Intermediaries keep the transaction cost low by setting prices, coordinating, monitoring and processing transactions, managing inventories, providing quality guarantees (Spulber, 1996), lowering the probability of an unsuccessful transaction,and reducing the time required to find a suitable trading partner (Rubinstein and Wolinsky, 1987; Cosimano, 1996; Fingleton, 1997a and 1997b). The new technologies of e-commerce create opportunities for changes in market structure. First, they enables traditional transactions to be performed electronically. Existing research posits that e-commerce can offer benefits not found in traditional environments for both direct and intermediated transactions (Malone, Yates and Benjamin, 1987; Bakos, 1991). E-commerce is hypothesized to lower search costs and product prices (Bakos, 1991). However, some of these benefits might not materialize as hypothesized in electronic markets (be they direct or intermediated) (Clemons, Hitt and Hahn, 1998; Lee, 1998; Brynjolfsson and Smith, 2000). If electronic markets do not have any relative advantage (Rogers, 1983) over traditional markets, they will not be adopted (Chircu, Davis and Kauffman, 2000). Second, e-commerce technologies have the potential to impact the way that transactions are performed. Because emerging e-commerce technologies are hypothesized to reduce, sometimes significantly, the transaction costs, researchers have proposed that intermediaries will be partially or even totally eliminated, or disintermediated, in electronic markets (Malone, Yates and Benjamin, 1987; Benjamin and Wigand, 1995; Gellman, 1996). This hypothesis, however, has received limited support from practice. Empirical studies report that intermediaries can still remain in the e-commerce value chain and that they still have important transaction support roles in e-commerce (Hess and Kemerer, 1994; Sarkar, Butler and Steinfield, 1996; Bailey and Bakos, 1997; Chircu and Kauffman, 2000a). Reports from practice also paint a contradictory picture of the advantages and disadvantages of electronic intermediaries versus electronic direct markets. Some practitioners predict that the e-commerce marketplace of the future, by enabling a potentially infinite number of direct connections between buyers and sellers, will lead to “the death of the middlemen” (Tapscott, 1995; Leebaert, 1999). Evidence from practice, especially from business-to-business e-commerce, suggests that direct electronic commerce trade can be beneficial for a variety of situations such as transacting perishable goods, excess inventory, or high fixed cost assets (Leon, 1999; Sawhney and Kaplan, 1999; Biri Singh, 2000). Still other practitioners and academic authors argue that “the middleman lives” (Chircu and Kauffman, 2000a; Mougayar, 2000; Dai and Kauffman, 2001). In other business-to-consumer transaction-making contexts, new kinds of middlemen called infomediaries are predicted to emerge and control the flow of information between buyers and sellers (Hagel and Singer, 1999; Mougayar, 2000). Viable business models for e-commerce intermediaries have already been implemented, and they compete head-to-head with direct trading mechanisms for attracting buyers and sellers (Biri Singh, 2000). As the initial hype surrounding electronic commerce passes, both researchers and practitioners have a vested interest in understanding the kinds of business models companies are experimenting with today that will be successful in the long run. Our approach to sorting out these contradictory results is to build a new theory of intermediation that draws upon established models for intermediation in traditional markets, and to assess the changes prompted by e-commerce technologies. By explicitly incorporating the characteristics of the transactions in both traditional and electronic markets, this theory will enable us to fully explain the structural changes in these markets. In this paper, we show how several economic theories and models of intermediation can be combined to formulate a framework for market structure changes in the presence of technological innovation for electronic commerce. We then apply the framework to three different cases and verify that it can correctly explain the outcomes we see in each case when e-commerce technologies are introduced in the market. THE IMPACT OF E-COMMERCE TECHOLOGIES ON MARKET STRUCTURE To explain the changes in market structure in the presence of technological innovations for ecommerce, two market characteristics need to be taken into account. They include the degree of intermediation (direct versus intermediated) and the extent of the availability of electronic commerce technologies in the market (traditional versus electronic). We call the latter concept degree of technological intensity . These two characteristics define four types of markets, each with a unique combination of technology and intermediation structure: • direct traditional markets (DTM) • direct electronic markets (DEM) • intermediated traditional markets (ITM) • intermediated electronic markets (IEM). Table 1 illustrates our conceptualization of the four possible types of market structures, which enable the investigation in more detail of how e-commerce technologies trigger the transition from one type of market structure to another. This will also permit us to examine a number of hypotheses that have been asserted, especially the “electronic disintermedia tion” hypothesis, to determine some of the conditions under which the market is likely to change in accordance with them. Table 1. Four Types of Markets Our survey of the literature points out that, as far as the traditional markets are concerned, a number of theories regarding the competition between direct and intermediated market structures have been already formulated and partly verified empirically (Spulber, 1996; Rubinstein and Wolinsky, 1987; Cosimano, 1996; Fingleton, 1997a and 1997b). Most traditional markets are intermediated: buyers and sellers for real estate use real estate agents, the trading of new and used cars is supported by car dealers, and travel products are sold and purchased primarily through travel agents. Direct traditional markets exist for used cars, antiques and collectibles (for which buyers and sellers meet directly through classified ads), in the case of “for sale by owner” real estate transactions, or for travel reservations made by calling a specific airline directly, as shown in the table. However, the existing research and evidence from practice does not fully explain if buyers and suppliers transacting in a traditional market will find more benefits in an electronic market. Figure 1 shows that there are still unanswered questions regarding the change from traditional to electronic markets, or the choice of direct or intermediated market structures in electronic markets. We still have few theories and empirical tests that can answer these questions, and in many cases the results of existing research are contradictory. Do intermediated electronic real estate transactions conducted through an intermediary such as Realtor.com offer more benefits that “for sale by owner” direct transactions in a Degree of Intermediation in the Market Direct Markets: Buyers and sellers trade directly Intermediated Markets: Buyers and sellers trade through a middleman Traditional Markets: No Internet technologies are used for transacting Direct Traditional market (DTM) Examples: “for sale by owner” real estate, classifieds for used cars, antiques, collectibles; direct phone travel reservations Intermediated Traditional Market (ITM) Examples: real estate, new and used cars, travel reservations using travel agents, insurance, markets for stocks and bonds Availability of ECommerce Technology in the Market Electronic Markets: Transactions are conducted using Internet technologies Direct Electronic Market (DEM) Examples: direct online travel reservations (nwa.com), direct online purchases (niketown.nike.com), online classifieds (Excite Classifieds at www.classifieds2000.com), used car auctions (Japanese AUCNET auction at www.aucnet.co.jp/e/), collectibles (eBay.com), Intermediated Electronic Market (IEM) Examples: real estate (Realtor.com), new and used cars (CarPoint.com, AutobyTel.com), travel reservations (Expedia.com, Orbitz.com, Priceline.com), bonds (BondBook.com) traditional environment? Will buyers and sellers adopt direct electronic transactions instead of using traditional intermediaries, such as in the case of transacting airline tickets through an airline’s own website (such as American Airlines’ Web site www.aa.com) as opposed to through a traditional travel agency? Will traditional intermediaries be replaced by better, more efficient online intermediaries, such as with online travel intermediaries Expedia.com (www.expedia.com) and Orbitz.com (www.orbitz.com) replacing traditional travel agents, or electronic stock trading through E*trade (www.etrade.com) replacing broker-assisted trading? Or will traditional intermediaries be supplemented by electronic travel intermediaries, as it happens with real estate agents that can now post their offerings on the website of electronic intermediaries such as Realtor.com (www.realtor.com)? Figure 1. Impacts of Internet Technologies on Market Structure: Unanswered Research Questions