Electronic Markets and Electronic Hierarchies: effects of Information Technology on Market Structur Corporate Strategies

This paper analyzes the fundamental changes in market structures that may result from the increasing use of information teChnology. First, an analytic framework is presented and its usefulness is demonstrated in explaining several major historical changes in American business structures. Then, the framework is used to help explain how electronic markets and electronic hierarchies will allow closer integration of adjacent steps in the value-added chains of our economy. The most surprising prediction is that information technology will lead to an overall shift toward proportionately more coordination by markets rather than by internal decisions within firms. Finally, several examples of companies where these changes are already occurring are used to illustrate the likely paths by which new market structures will evolve and the ways in which individual companies can take advantage of these changes. Analytic Framework Economies have lwo basic mechanisms for coordinating the flow of materials or services through adjacent steps in the value-added chain: markets and hierarchies. Markers coordinate the flow through supply and demand forces and transactions between different individuals and firms. In markets, buyers choose among many potential sellers. Hierarchies coordinate the flow through managerial decisions rather than market forces. In these hierarchical relationships (which sometimes include legally separate firms in a sold-supplier relationship) the buyer has only one supplier. We can analyze the relative advantages of markets and hierarchies in terms of tradeoffs between production costs and coordination costs. In general, since markets allow production resources to be shared among more buyers, they have lower production costs than hierarchies. But markets also require buyers to gather more information about potential suppliers and they are more susceptible to costs that arise from dealing with "opportunistic" trading partners. Therefore, in general, markets have higher coordination This paper is forthcoming in Communications of the ACM.