Martin Kenney is Professor, Department of Applied Bahavioral Sciences, University of
California, Davis. email@example.com
James Curry is Professor, El Cologio de la Frontera Norte, Tijuana, Mexico.
The authors thank John Zysman for helpful comments.
This paper examines the impacts of the Internet on business activity. Established
corporations and startup firms are utilizing the Internet to create new markets and
reorganize existing markets. Ubiquity and low cost make the Internet a powerful force for
transforming business activity and facilitating new venture creation. Firms are using
online retailing to circumvent traditional establishments, open portions of their
information systems to customers, and link firm processes directly to the consumer by
moving functions such as purchasing online.
The 1931 movie, Cimarron, had a memorable scene with a panorama of an enormous number
of covered wagons lined up to participate in what would later be called the Oklahoma Land
Rush. This scene captures the essence of the Internet rush. In 1990 the U.S. National
Science Foundation approved the use of the Internet for nonacademic uses, but it was only
in 1993 that the technologies were developed making possible the World Wide Web (WWW). The
key breakthrough was the release of software able to generate the appropriate data that
could be transmitted over the Internet to a users machine where it would appear as
visual images. The result has been nothing less than a global cyber rush, similar to the
Oklahoma Land Rush, as individuals and businesses have rushed into cyberspace, a place
where anyone can have a site almost by simply claiming it. In this paper we examine some
of the initial commercial uses of this new space, while recognizing the very preliminary
nature of our findings.
Among all the remarkable aspects of the Internet, the speed of its adoption is,
perhaps, the most noteworthy. The growth of Internet users from 5 million in 1993 to 62
million in 1997 and nearly 100 million in 1998, is one of the fastest adoption rates any
technology has ever experienced (Department of Commerce 1998: 8, Caginalp 1998). Traffic
on the Internet continues to double every 100 days, according to Uunet Technologies, an
Internet backbone provider (Caginalp 1998).1 Even faster than user
adoption rates, the number of domain system names (registered sites) registered has been
increasing at an annual rate of 40 to 50 percent, reaching about 29.7 million at the end
of 1997 (Glave 1998). And, most important for this article, the number of commercial names
(.com) increased from 27,000 in January 1995 to over 765,000 in July 1997. Since the U.S.
was the leader, most analysts expected this pace to continue until after the year 2000.
Since the movement to Web-based commerce is spreading globally, there eventually may be as
many as 550 million users and a far greater number of commercial sites than currently
It is hazardous to guess what the Internet will mean for commerce. Schumpeters
metaphor of new technologies opening new spaces appears particularly appropriate for the
Internet insofar as it is a vast new region being colonized by a nearly unlimited variety
of activities with no inherent relation to the technology itself. In other words, like the
telephone it is an enabling technology. In the realm of economic life, there can be little
doubt that this is a classic case of the creation of what Schumpeter (1969) termed a
"new economic space."
The development of a particular technology certainly does not entirely determine, in
the strong sense, the nature of the changes underway. However, as a tool, the Internet
will be used in ways that will transform existing relationships such as those between
buyers and sellers, workers and owners, and suppliers and assemblers. In the process there
will be important changes in institutions such as manufacturing firms, service providers,
and retailers. Here we are careful not to claim that technology mandates a particular
institutional outcome(s). Our position is rather that drastic changes are already underway
and the pace of change will intensify.2
The power of the Internet is its simplicity; it is merely a medium for connections and
is able to transmit anything digitized. Unlike prior communication systems, such as
telephony, which established a dedicated connection between two (or sometimes more) nodes,
the Internet allows the simultaneous exchange of information in digital form among an
unlimited number of nodes. The protocols used to transmit data across the Internet are
standardized and readable by a multiplicity of computing platforms. To this is added the
innovation of hypertext, that is the ability to almost effortlessly move from node to node
at a whim. The information content of the Internet is almost completely dephysicalized or
dematerialized. It is reduced in its physical essence to the most abstract possible
formulation: 1s and 0s carried by laser light, electrons, or electromagnetic waves.
Multi-platform accessible standards, hypertext, and dematerialization are forcing and
combining with a remarkable increase in the capacity of global telecommunications systems
to rapidly reduce the costs of communicating digital data. The extreme flexibility of the
Internet allows it to be used for a large number of activities with differing real world
manifestations. Activities as diverse as booking airline flights, purchasing items,
playing games, viewing pictures, listening to music, or accessing public information, many
of which formerly were intermediated by human operators are being transferred to the
Internet. The dimensions and plethora of activities related to the Internet are
increasingly impossible to fully comprehend and this immensity is emblematic of its power.
This essay discusses several different areas in which the Internet will significantly
impact the current organization of economic activity. It begins with a brief discussion of
the difficulties contemporary social sciences have in explaining the new technologies and
their effects. The next three sections consist of a general examination of the development
and capabilities of the Internet as they relate to commerce, a more focused discussion of
the capabilities of the web for enhancing customer service, and a general examination of
the economic and organizational impacts of web-based commerce. This is followed by three
sections which examine exemplary areas in which the commercial application of the Internet
is leading to new approaches to doing business, or otherwise having a major impact on the
way business is already conducted. These factors underlie the current push for the
development if the web "portal" sites, the direct marketing model of personal
computer assembly and sales, and the use of the Internet to streamline interfirm
transactions. The penultimate section addresses the advantages of being first to exploit a
particular niche or opportunity. Finally, in the conclusion, we raise the question as to
whether the Internet will lead to the proliferation of numerous niche businesses, or
whether certain technological and economic exigencies will lead to domination by a small
number of very large content aggregators or product marketers.
Theorizing New Economic Space
The Internet is a key aspect of the ongoing transformation of the global economy to a
form in which materiality becomes subordinate to information and knowledge creation. More
than merely a new communication system, the Internet represents the creation of an
entirely novel economic space. By connecting computers the Internet allows direct access
to processes and procedures, which were formerly cordoned off in the back offices and data
processing centers of government and corporations, while also creating entirely new
sources of information. The Internet makes a vast mass of information, images, and
opinions accessible to any owner of a connected computer. It is an interactive
communications medium through which the user accesses information that would have
previously taken much time and physical effort to find. The Web is remarkable because the
user has the sensation of travelling, though in reality the user is only electronically
reaching out and retrieving data to be visualized on a computer monitor. In this process
the costs of information search drop dramatically.
Even though there is no certainty about the ultimate configuration of Internet-related
commerce at maturity, businesses such as stock trading, bookstores, airlines, and PC firms
are already migrating on-line. Virtual stores are being created with virtual inventories
far larger than any physically existing store. Because their inventory of products
available is entirely computerized, the customer rapidly pinpoints the exact product
desired by using specially tailored database query software. These products can be
drop-shipped from a production or distribution node to anywhere in the world using the
various courier services that are now on-line. The Internet eases many market entry
barriers because of minimal startup costs, thereby dramatically accelerating the
realization of an idea and allowing successful ventures to grow exponentially.
The Internet represents an extremely powerful dematerialization. It is no longer
necessary to disseminate information in the physical medium of paper, floppy disks, or
CDs. It can now be communicated through electronic impulses and/or beams of light (fiber
optics). Such flexibility and ease of use accelerates information flow and communication,
facilitating new knowledge creation and novel forms of social production. These changes
have been most pronounced in the software development area. Though the distribution of
commercial-class software over the Internet is still only limited, already in existence
are vast downloadable stores of freeware and shareware programs, and numerous product
demos, service updates, and bug fixes. Many software developers use the Internet to
publicize and distribute test versions of innovative software programs such as the Opera
browser and The Brain user interface. The Internet also facilitates the development,
distribution, and maintenance of the alternative freeware Linux operating system and
Apache web server. These programs are the result of the collaborative efforts of thousands
of users/developers for whom the Internet serves as a virtual software development campus.
According to the chairman and founder of Netscape, Jim Clark (1995: 70) new business
models are possible because
The Internet is low cost. We proved that by using the Internet to distribute our first
product, and we were able to build a customer base of 10 million users in just about nine
months. Our only expense was the engineering cost of making the program . . . So we see
this potential for low cost distribution of any kind of intellectual propertywhether
software, or pictures, or movies, or compact disks, or anything that can be represented as
An example of the curious economics of the Internet is McAfee Associates, a producer of
antiviral software, which adopted the capture "mind share" strategy and
pioneered free Internet software distribution. McAfee has said "if you give software
away and assist people as well, youre almost bound to make money" (Leon 1997).
After providing free software to five million users, McAfee shifted into a marketing mode
and started charging for upgrades, add-ons, and new updates. This kind of practice is
becoming quite common; even Microsoft, probably the most aggressive seller of
software posts trial versions of some programs, such as Money and Outlook 98. Since
computers and networks constantly evolve, the customers actually evolve with the software
in the form of upgrades. From the perspective of traditional economics, practices such as
giving products away for free seem foolhardy and even perverse. Recently, however, some
economists and business theorists have begun rethinking traditional economic concepts to
encompass the value-added from knowledge creation and the "winner-take-all"
aspects of capturing or becoming standards in information-and communication-intensive
industries (Arthur 1994; David 1986; Shapiro and Varian 1999).
Economic puzzles like these are only the tip-of-the-iceberg, there are other phenomena
pressing beyond the boundaries of traditional social sciences. User communities, at a
number of web sites online actually become an integral component of the value of the site,
as opposed to the consumers in the non-Internet market. For example, readers reviews
are posted at Internet bookseller, Amazon.com (Hagel and Armstrong 1997). The user
community creates value in a profoundly social sense. This goes beyond the ideas of
sociologists such as Granovetter (1985) in his discussion of the embeddedness of economic
institutions. The social (community) interaction process and its concomitant communication
of information and opinion creates the value of a web site. The ability to search
online for a book and purchase it is reproducible, the online community is not.3
The Internet is creating another level of social internetworking. Castells ( 1996)
wrote about the "rise of the networked society," as if the nature of human
society was not inherently networked. The issue is not really the rise of a networked
society, but rather the reach of the networks and their increasing bi-directionality.
However, the new level of networks described by Castells will lead to important
qualitative changes in the economy and society, though it is somewhat premature to
speculate on the social changes. The increased penetration of electronic data transmission
networks will surely have an impact, this paper builds upon Castells observations
and initiates an analysis of exactly what these might changes in the economic realm might
The creation of online or virtual communities occurs through the medium of virtual
places. Certainly, worldwide web servers provide Internet surfers with the electronic
analogue of visiting an address (Batty 1997). Although it is really only a software
construction on a computer server connected to a telecommunications pipeline through which
the user retrieves information (Mitchell 1995). And yet, the metaphor of place in
cyberspace is rapidly becoming accepted by most Internet users. However, this was not
always the case; as late as 1990 Mitch Kapor and John Perry Barlow (1990) observed that
the old concepts of property did not apply well "in a world (that of the Internet)
where there can be none." This idea of a virtual place in space is a vexing issue in
capitalist economies where space is measured, marked, and owned. Marking and ownership
systems, however, are being developed. For example, World Wide Web addresses are becoming
valuable property as Compaq can attest when it paid $3 million for the Altavista web
The Internet and Commerce
By the early 1990s the Internet hosted a vast collection of useful information and
downloadable software. However, most of the tools for accessing this information were
primitive and required a certain amount of expertise and system knowledge on the part of
the user. Over time a number of key innovations were developed, reflecting a long
tradition of collective development of network technologies, standards, and protocols
funded by the Federal government. These were all designed to make the Internet more useful
to the academics and computer scientists who were the Internets main users. The
breakthrough came with the World Wide Web (WWW) and Hypertext Mark-up Language (HTML)
protocols, which were developed by researchers at the European Laboratory for Particle
Physics (CERN) in Switzerland in order to facilitate the exchange of information among
physicists. Thereafter the obvious next step was to develop special software, the browser,
which made the utilization of these and other protocols invisible to the user. A number of
different browsers were developed, some more functional than others, and were distributed
freely over the net. One of the early browsers, Mosaic, developed at the National Center
for Supercomputing Applications (NCSA) at the University of Illinois Urbana-Champaign
became wildly popular with millions of copies downloaded in a few short months after its
release. The group that created Mosaic was recruited and moved to California to build the
first commercial grade browser, forming the company named Netscape. Netscape added the
final key innovation, building secure transaction capability (Secure Sockets Layer, or
SSL) into its browser (Quittner and Slatalla 1998). This enabled Internet users to safely
and conveniently exchange money for products to be delivered over the net itself or by the
already extant and highly sophisticated delivery systems such as Federal Express, UPS, or
the USPS. Once all these pieces of the puzzle were in place, the success of the Internet
as a commercial medium was all but guaranteed.
Despite the seemingly obvious commercial applicability of the Internet, no one dominant
model of doing business has yet emerged. The Internet has presented itself to business as
uncharted territory, forcing firms to blindly grope for strategies that work. Those firms
who wish to succeed in Internet commerce have had to confront three unique
characteristics. The first is ubiquity. By this we mean that all "places" on the
Internet are accessible to the user on what is essentially an unlimited and equal basis.
The user can go anywhere on the net with a minimum of effort; there is no inherent
technological reason for the user to start at a particular point.
One entry point to the WWW is the proprietary network services predating the rise of
the WWW in the mid-1990s, such as America On Line (AOL), Prodigy, and CompuServe. But
these services had to adjust their business models and, in fact, Compuserve was acquired
by AOL. Moreover, most, if not all of the services provided by more delimited systems are
available at either free or subscription stand-alone web sites. Thus, commercial content
providers must find ways to attract people to their site, either by providing attractive
content for them to consume or some service or product they want to use or buy, or by
creating a system for purchasing non-Internet specific products that offers something
conventional retail channels do not.4
The second important characteristic of the Internet is interactivity. The Internet
itself was developed through a remarkable process of interaction by researchers located
around the world. Commercial publishers who wish to succeed on the Internet must offer
more to customers than that which is ordinarily available in print or from some other
media. One of the more successful web publishers has been the Wall Street Journal, which
has seen steady growth in its paid subscription base since it connected to fees about 2
years ago. The Journals site offers not only standard print content, but also a wide
range of content and services not found in the print addition. These include articles from
other Dow Jones publications, past article search and retrieval, customized stock quotes,
job finding information, a database of company background information, interactive
discussion of various current news topics, a news audio feed, the ability to customize the
web page to the users interest, and numerous other features. The Journal site serves
both as a substitute for those with limited access to the print version, such as overseas
readers, and as a complement to print subscribers who wish to access additional services
such as company and stock tracking from a source they know and trust.
The interactive nature of the Internet also gives rise to new forms of collaborative
activity. Some software firms place nearly completed software (beta releases) at a web
site and encourage computer aficionados to install the software and test it for bugs,
functionality, and features. The aforementioned Linux and Apache software programs have
relied on the Internet for both their dissemination and their continuing technological
evolution. Here, consumers actually participate in the knowledge creation process by using
a new product and communicating the results back to the company. Netscape, for example,
pre-releases unfinished versions of their software over the Internet for this purpose.
This diminishes some of the burdens of in-house testing and decreases the distance between
software creators and customers by creating an information feedback loop. Moreover,
integrating a subset of customers directly into the product development process also
accelerates the creation of demand for the finished product.
The third important characteristic of the commercial Internet is speed (Davis and Meyer
1998; Kenney and Curry 1998). Because the Internet is an ubiquitous, interactive system
based on a multipurpose digital computing platform, changes such as system software
upgrades, new standards and protocols, and new publications (content) can be developed and
disseminated very rapidly. The availability of out-of-the-box network and network server
hardware and easily adaptable software applications such as credit card billing systems
and searchable databases enables the rapid development of commercial systems at very low
cost. Moreover, many Internet-based businesses have been developed as overlays on existing
infrastructure, which further reduces startup costs and time of deployment. The rapidity
at which businesses can be established on the Internet places a great deal of emphasis on
being the first in a particular market category. An interesting case in point is
Amazon.Com, an Internet bookseller based in Seattle. By relying on existing systems of
distribution as a sort of retailing adjunct to them, Amazon was able to start operations
quickly and efficiently (Bianco 1997). By purchasing advertising link space for itself on
the Internet from frequently visited sites such Netscape's, Amazon developed a high volume
business in a very short time (Southwick 1996). Founded in 1995, Amazon had over $116
million in net sales during the second quarter of 1998, an increase of 316 percent over
net sales of $27.9 million for the second quarter of 1997 (Amazon.com 1998). Barnes &
Noble, an important innovator of large, high variety, bookstores, has only recently
recognized and introduced book selling on the Internet as a logical extension of its own
large-scale distribution and inventory-tracking system (Marcial 1997). But, by entering
the Internet book sales arena late, Barnes & Noble is having great difficulty
Given the assistance of customers, product evolution in Internet software is extremely
rapid (Reid 1997). The leading personal computer software company, Microsoft, only saw the
potential and danger of the Internet in late 1993, though after that it moved very quickly
to exploit the new opportunity to overtake the leader, Netscape. Microsofts strategy
was to rapidly improve its Internet browser and include it in the Windows 95 software
package. By the end of 1997, Microsoft was rapidly taking market share from Netscape. A
"browser war," as well as a legal has begun as Microsoft works to cripple
Netscape using various stratagems.
The Internet economic space opened quickly and continues to provide many possibly
transformative opportunities. Leadership roles in previously stable and even stagnant
activities such as book selling, travel agency, and telephone ticketing are in a state of
flux. For the airlines, the Internet made it feasible to create online reservation systems
that they could control and use to reduce the power of travel agents. There were also
significant savings, because the cost of issuing an eticket is only one dollar, whereas a
telephone ticket costs eight dollars spurring changes for the highly competitive
airline industry because of these compelling economics.
The Internet could also impact the local newspaper as a materialized source of
information delivery. The initial approach to simply place the newspaper on a web site has
failed. What may evolve is that various web sites will replace different components of the
newspaper. Already there are entertainment oriented "lifestyle guides," such as
Microsofts Sidewalk sites. There are many sports and business-oriented web sites
that might replace or, alternatively, complement the sports and business sections. Like
the Wall Street Journal, these sites offer a level of interactively accessible information
that would be cumbersome in printed form. The most important impact on newspapers might
come from Internet-based classifieds since they are a key source of revenue for
newspapers. Inexpensive local classified ad sites are already available on the Internet.
It is likely that the classifieds will eventually become interactive, allowing direct
responses to ads through email, or even more interactively through a chat program. The
variables that will determine the fate of newspapers hinge upon the issue of whether
readers appreciate the variety, including national and local news, sports, business,
weather, and advertising etc. in hardcopy. The electronic analog does not appear
satisfactory at this moment.
It is still quite early in the development of the Internet and related data
communications, so the possibilities of the new medium are only beginning to be explored.
Old activities such as making phone calls, sending mail, and ordering goods and services
are already migrating to this nearly instantaneous environment. And, as important, for
this paper, many formerly relatively sedate industries are finding parts of their value
chain absorbed and accelerated to computer and Internet time. As a result, some local
businesses can go global and experience dramatic growth, while other local businesses will
be outflanked by competitors from anywhere on earth and experience decline.
Customer Service Functions
Customer service functions have always been a time-consuming person-to-person activity,
however much of this is highly routinized. An important recent step in automating customer
service was telephone call processing, but this was a slow system with very low bandwidth.
In other words, an excessively long menu of choices leads to consumer disconnection and
difficulties in creating user-friendly branching systems. More sophisticated non-human
intermediated customer service would have to wait until the consumer had a device able to
handle greater amounts of information, i.e., the PC and a computer modem. When the
installed base grew and the technology was sufficiently mature it became possible to place
information on a server open to customers. This redefined customer service by increasing
the level of provision while decreasing the cost. This was possible because most
interactions are entirely standard. For example, many customer questions are for routine
information such as store hours and directions. Answers to such questions can be codified,
indexed, and stored on a server to be accessed online and downloaded. For simple questions
such as directions the Internet can download a map, whereas on the telephone error-prone
verbal instructions are necessary.5 Essentially, customers can access the
information they need to find and create value for themselves from the providers web
site at practically no-cost except the initial startup costs.
In addition to seeking routine information, customers are also attracted to sites that
provide detailed information about products or services. A potential customer can browse
several competitors' sites, as well as third party sites, which discuss the product in
question, compare prices and features, gather general information about a particular
product or type of product, taking as much time as desired before making a purchase. A
recent study at the Fuqua School of Business at Duke University found that consumers were
more likely to buy products from sites that provided comprehensive information than from
sites that had slightly lower prices but little in the way of useful information (Bransten
1998). The point is that the user can select the desired amount of information, removing
the need for the information provider to make decisions based on an "average"
The types of customer service provided online depend upon the firms product or
service. For example, software companies make available various software patches, add-ons
to current products, and/or demos. Increasingly, software programs such as Microsoft
Windows or Netscape Communicator have the ability, upon a prompt from the user, to
automatically check for updates and then download and install them. Delivery through the
Internet is essentially without cost and has the added benefit of developing a connection
with the customer. In other cases, service bulletins or product-related information are
placed on company web sites for informational purposes. These relatively straightforward
applications replace or augment previous product upgrading or information dissemination
Global logistics firms, such as DHL, UPS, and Federal Express, have taken the potential
for customer service much further. Federal Express, one of the aggressive first-movers,
has opened the tracking portion of its computer system to Internet users. Federal
Express initial effort on the Internet was a one-way information provision service
customers could use to receive information about the location of the shipment and its
arrival time (Lappin 1996; Grant 1997). The success of this initial effort spurred Federal
Express to consider other ways to use the Internet. Based on its experience with the
tracking service, a web site was developed to permit customers to use the Internet for all
their shipping functions. The features now available include scheduling pick-ups, detailed
maps of all drop-off locations, rate charts, and other information regarding international
customs regulations. Moreover, the site offers free downloadable software that speeds the
processing of shipments, allows the user to store addresses in an address book, maintains
a shipping history in a log, and creates and prints labels (Fedex.com 1998). Many shipping
office functions have been transferred onto software and into data communications
networks. Human intermediaries and physical documents were replaced by software. Not only
is it less expensive than previous methods, but it also provides the mechanism for
creating whole new ways for firms and their customers to interact. Most critical, the
information provided through the server gives the customer the resources to create value
from the site.
The reasons consumers purchase retail items are complicated and, at times, non-rational
(we discuss interfirm purchasing in another section). Of course, one reason is plainly
utilitarian, but, of course, there are other more emotive motivations. Today, the Internet
is establishing an entirely new retailing channel that is already affecting traditional
retail industry. As we shall see, building successful Internet retail web sites is
significantly more complex than simply moving a catalog online. A web site must create a
feeling that it is the place to go to buy something.
The use of Internet retailing will transfer an increment from traditional channels to
online. Fred Smith, the founder and CEO of Federal Express has an apocalyptic (and
somewhat self-serving) vision, "The Internet is going to make it very difficult for
anybody in a middleman position to stay in business
the same type of effect that
Wal-Mart had in the retailing sector thats what the Internet is going to do
to every business (Lappin 1996: 286)." No previous communications technology has
allowed the customer to personally search databases of, for example, books, autos,
software, airline schedules, and then complete the purchase without face-to-face
interaction. In traditional commercial locations deployed a service worker (or
intermediary) that communicated with a customer while interfacing with a computer and
performing search and booking procedures. With Internet browser technology it is possible
to remove the service worker as a translator between the analog customer and the digital
database or to "disintermediate" the relationship. This makes it possible to
reconceptualize activities that formerly required human service workers and directly
connect customers to firms computers. With credit card payment the entire process is
electronic with the exception of delivery for some goods, such as insurance, stock
certificates, and financial instruments, there is nothing but an accounting notation in a
There are remarkable benefits for a retailer that can transfer sales activities to the
Internet, though they vary by product or service. For many services in which there is no
physical component at all it may be quite easy to move the entire process online. A
general benefit is that an Internet retailer can hold far less inventory than a
conventional retailer who must have the items in inventory thereby tying up capital. The
difference can be striking. For example, Amazon.com, the online bookseller, turned its
inventory over 42 times in 1997, whereas its largest competitor, retail store-based Barnes
& Noble turned inventory only 2.1 times (Willis 1998). Moreover, a significant portion
of Amazon's inventory is held by distributors who ship the items directly to the customer
although this is changing as Amazon attempts to develop a system of buying directly from
publishers (Bianco 1997). Book retailing could experience even further radical changes as
new electronic book devices arrive in the marketplace. For example, devices enabling books
in digital form to be downloaded by phone or potentially over the Internet. An early
example of this is the four hundred page book Emerging Digital Commerce published
by the U.S. Department of Commerce (1998) using Adobe Acrobat and can be printed in a
book-like format. In another inventory-sensitive market, one of the several automobile
retailing web sites, Auto-By-Tel, had an annual rate $6 billion in sales at the end of
1997, up from $1.8 billion the previous year (Reuters 1998).
Lower inventory reduces risk from market vagaries. Internet-based retailing eliminates
the costs of retail branches, thereby lowering initial entry costs and the fixed costs
associated with retail stores. Moreover, the use of the Internet for sales combined with
delivery firms such as Federal Express and UPS extends the customer base from the
relatively local reach of individual stores to anyone anywhere in the world having access
to a PC with a modem and a credit card. In addition, because the merchants server
operates constantly, purchases can be made day or night, any day of the year. Distance is
dramatically shrunk, while time is extended to its maximum.
Complicated sets of purchasing decisions such as booking travel and hotels can be
undertaken on-line without human intervention. For example, air travel, car rental, and
accommodations can be booked at an online travel site. The on-line travel agent can go far
beyond a telephonic travel agent by providing much broader and more detailed information
including textual descriptions, images, and even reviews of the various destinations. In
effect, huge databases of information can be made available to the customer in such a way
as to allow users to "customize" their travel agenda. In essence, the customer
produces a uniquely customized product from an entirely standardized set of choices.
The convenience and availability of information are important advantages. However,
online travel agencies have yet another advantage, namely, they can post comments from
previous travelers, thereby creating interaction and information exchange. This
multiplies, simplifies, and makes interactive the "letters to the editor"
columns found in newspaper travel sections. The interactive possibilities permit online
discussions regarding specific types of travel, such as ecotourism, folk festivals ad
infinitum. This virtual community adds value to the site and is a mechanism for retaining
customers who can change sites at the click of a button. Moreover, the knowledge generated
through these discussions could permit the discovery of new market needs, thus giving rise
to new products. The community and its interactions add value that the travel agency does
not need to compensate.
Compare the economics of an online travel agency with that of a conventional agency. At
the conventional agency a person deals directly with the customer in a situation in which
the time spent with a customer on a booking is a direct cost. In essence, each interaction
with the customer is a cost. As mentioned earlier, it costs an airline one dollar to book
a flight on the Internet and eight dollars through an airline customer agent (Department
of Commerce 1988: 28).6 In addition, travel agents can make mistakes,
however on the Internet the customer bears full responsibility for the reservation. In the
case of the conventional travel agency, return business is dependent upon building an
interpersonal relationship with the customer. The online travel agency uses the online
customer community to develop relationships between the customers and with its site in the
hopes of encouraging repeat business (Hagel and Armstrong 1997).
The travel agents experience combined with a personal relationship with the
traveler can be seen as knowledge base that enabled them to make recommendations to
improve the traveling experience. The travel agent was a form of expert knowledge.
Customers not utilizing the travel agents knowledge base, in effect subsidized those
using the knowledge. However information on travel habits, previous travel, and other
characteristics (i.e., a profile) allows the computer to search its database and match it
with similar profiles to be used to offer "personalized" services to a customer.
The success of online travel agencies is apparent (Needle 1998). For example,
Microsofts Expedia site launched in 1996 had more than $12 million in monthly sales
in January 1998 and was growing quickly (Lipton 1998). As important, the U.S. travel
industry is being reorganized, not only with new entrants such as Microsoft, but also as
the airlines are reducing the fees they pay to travel agents and encouraging customers to
buy tickets directly through their web sites. In the process these web sites are being
built into virtual places. For those desiring human contact, the offline travel agent will
remain available, but increasingly they will be paid for directly by the user, witness the
increasing use of service charges by the offline travel agencies (a tactic that will
accelerate the movement of customers to the online agencies).
To recapitulate, the technical capacity for online retailing can be understood by
seeing the two tendencies that were integrated by the Internet. First, the decreasing cost
of long distance telephone service meant many customer transactions had already been
centralized into call processing centers especially for the purchase of products such as
tickets, software, computers etc. Second, the development of sophisticated database
management software and the use of corporate Intranets serviced by large-scale computer
servers meant that the purchasing process had been largely computerized. The service
worker using a networked computer to take an order was merely an intermediary between the
customer and the corporate database. On the demand side, the increased usage of email, the
development of expensive, user-friendly browser, personal computers with faster modems,
and more persons attached to high-speed local area networks created a large installed base
of potential consumers. The final step was to habituate customers to purchase items
through cyberspace. As more and more consumers are online, old retail methods will be
eclipsed since consumers have vastly more information at their disposal, not only about
the products available, but about their prices as well. Premium list pricing will be more
difficult to maintain as consumers can nearly effortlessly find the lowest priced vendor,
or go to a site that aggregates the price information of several vendors.
The chaotic unplanned topology of the Internet creates difficulties for customers in
finding vendors (Watson et al 1998). Because of the ease in establishing a web site and
the inability to see the actual product, there is a heightened possibility of fraud, so an
element of risk is injected in the purchasing decision. This makes the brand name of the
web site extremely important. Some of the initial attempts at aggregating commercial web
sites operated on the metaphor of the shopping mall (Economist 1997). Here, a
number of vendors would create virtual stores at a single web site, the e-mall. The idea
here was for the vendors to pay rent for a site at the emall. The more creative of these
actually generated small buildings that the customer could click on to enter. This
business model built on the suburban shopping mall seemed entirely plausible. However, the
difficulties became obvious rather quickly. The shopping mall provides a centralized place
for consumers, who had moved away from traditional downtown shopping districts to the
suburbs. Prior to the automobile, the downtown had been served by public transit such as
streetcars and subways, so commerce clustered at its nodes. The fatal flaw in the emalls
was that there were no reasons such as convenience, less traffic, or crime that would
impel "shoppers" to visit the mall rather than go "downtown." In a
sense, the whole World Wide Web itself is the mall, or the shopping district (Cairncross
1997). Moreover, the shopping mall provides a social experience, whereas thus far Internet
buying is much more utilitarian.7
Another problem related to the relatively slow acceptance of the emall idea is
advertising. Many commercially oriented sites rely on advertising as either a full or
partial source of revenue. The proprietary online services such as Prodigy, MSN, or AOL
serve as excellent advertising vehicles since their users are forced to start with their
proprietary interfaces. AOL has been particularly successful with users who can, if they
wish, access the Internet directly, but who feel more comfortable using AOL's preselected
content (information, news, announcements, etc., and advertising) as their "home
base" on the Internet. The rise of the ubiquitous Web however, has challenged the
proprietary online service models since users with "direct" Internet connections
can essentially start wherever they want. This presents a problem for those companies who
seek revenue from advertising and/or linking partnerships with online vendors. Like any
other medium, the more viewers you attract, the more you can charge for advertising. Thus,
with the viewer free to roam, the focus shifts from getting people online, to getting
people who are online to go to your site.
This has led to the recent idea of developing content aggregation sites, or as they are
more commonly known, web portal sites. The ideal behind portals is to create sites which
have a great deal of general utility to users, so that users will visit them frequently,
or set them as their default start sites. So, for example, users go to Yahoo to access not
only its categorization and search capabilities, but also to access additional proprietary
or linked content such as email, chat, news and weather, telephone directories, games,
maps, etc. The enormous traffic thus attracted provides Yahoo with the opportunity to sell
lots of click-through advertising at profitable rates. Additionally, sites such as Yahoo
are able to sell more profitable targeted advertising. If a user searches
"computers" for instance, the site will return a page with a computer-related
banner advertisement; search "autos" and a car company advertisement may appear.
Rather than the failed suburban shopping mall metaphor, considering the subway stop and/or
node better approximates the new model. For example, in Japan or in Europe fixed rail
transportation nodes such as Shinjuku or Victoria Station (in the U.S., Grand Central
Station has some of these characteristics) are also commercial nodes where shops,
department stores, and other commercial activities are clustered. These establishments
feed off the traffic volume flowing through the stations. Moreover, travelers may
occasionally arrange their journeys to include stops at these heavily commercial nodes, or
plan trips whose sole purpose is to visit these nodes. With the Internet the potential
traffic is infinitely greater and since potential customers know they can find what they
want they are attracted to the location. Moreover, the portal site, because of the
interactive and hyperlinked nature of the Internet, potentially becomes something entirely
novel, a hypermall. Shopping in a hypermall is context sensitive instead of place
sensitive. Search "travel" in Yahoo for example, and along with the usual
categories of travel related sites (both commercial and otherwise) is provided with a link
to Yahoo's own travel booking service. Search "literary criticism" or some other
book-related topic, and Yahoo will provide a link directly to the particular topic area at
Amazon.Com (a Yahoo partner).
The one caveat to the viability of this scenario is that after visiting the
vendors site, the user may bookmark the vendor and not return again through the
portal. Whereas, at the subway station they will continue to return on their ways to other
sites. However, if the portal continues to be useful in other ways, and advertisers
continue to see value in portal associations, the approach could be stable. Hyperlinking
is also problematic in another way; at one time a specific portal site might have enormous
traffic, but due to the virtual nature of the landscape the "transportation"
links can be quickly and easily rearranged by users and traffic can evaporate quickly. For
example, Netscapes and Microsoft's web sites (including MSN) are among the top 10
most visited sites largely because they are the default setting on Netscapes and
Microsoft's browsers (RelevantKnowledge 1998). Part of the current mania for
portals is due to the realization on the part of Netscape and Microsoft that these default
links give their sites a large revenue generation potential.8 It is for
this reason that Microsoft's operating system browser integration is seen as a major
threat to Netscape. Should Microsoft successfully replace Netscapes browser, will
NetCenter lose its potential as a portal?9
PC Assembly and Sales
The PC is, of course, the user's vehicle for accessing the Internet. Also, it has
become one of the most popular products to sell on the Internet. The mail order and
internet-based retailers have adopted a system by which they have few, if any, computers
in inventory. For example, Insight, a mail order computer products distributor in Tempe
Arizona provides customers with a catalog (or web page) of products. They then handle the
order and payment and simply arrange for a main distributor or manufacturer to ship the
product directly to the customer. In fact, companies like Federal Express and UPS could
eventually provide the final assembly of the computers as part of their services (see
Lappin 1996). Still another variant of moving assembly temporally closer to the customer
are the unrelated decisions by Ingram Micro and Fujitsu to move their PC assembly to
Memphis, Tennessee as it is Federal Expresss hub. This will speed their reception of
parts and delivery to retailers or final customers.
Perhaps the most significant point to be made about the use of the Internet by the PC
industry lies in how it integrates the production process with the distribution process.
Direct marketing firms such as Dell Computer and Gateway not only demonstrate the
Internet's potential as a sales tool, but its potential to radically transform the way
production and distribution are organized. In its original conception, Dell's system was
not predicated on the Internet -- orders were handled by phone, fax, or by mail. Using the
Internet to take orders is a logical extension of the direct marketing logic, providing a
richer alternative to the previous methods of taking orders. More important, however, this
kind of ecommerce has the potential to transform what is a multi-tiered, disjunctive
process into one that is seamless and continuous. This is because the PC is a
general-purpose device assembled from a series of separate components linked through a
common set of architectural standards. Each PC can be directly customized to the buyer's
preferences leading to increased customer satisfaction without the risks inherent in
trying to perfectly forecast demand (Curry and Kenney 1998). In the case of Dell and
Gateway the customer goes to the web site, chooses a base configuration, and then chooses
such things as the amount of memory, the size/type of disk drive, the type of graphics or
sound, and add-ons such as a modem or network card. Once the computer is configured and
payment is approved, the order is sent directly to manufacturing and the PC is assembled,
tested, and shipped (see Serwer 1998; McWilliams 1997).
This takes the use of the Internet as a selling medium to an entirely new level. Rather
than simply creating a store to sell finished products (for instance, books in the case of
Amazon.Com), companies like Dell can create a system in which demand nearly exactly
matches supply. Manufacturing, distribution, and consumption increasingly become
inseparable abstract moments in a continuous process. From the consumer's point of view
all products are totally customizable; the customer can order their custom specifications.
From the manufacturer's point of view the problem of demand forecasting is minimized and
managerial focus shifts to streamlining production throughput.10
The reason the PC industry has been the leader in direct retailing is due to the
modular nature of its product. As of this writing few, if any, other products are
manufactured or marketed in the same manner. Whether other products could become like PCs
is both a technological and an economic question. However, it is possible to conceive of
some ways that this could change. For example, as knowledge of the PC direct marketing
experience becomes more widespread, some firms may develop similar approaches with
products that are already somewhat modular, or are in some other way amenable to
Internet-based customization or distribution. Networking hardware producer Cisco Systems
already has an extensive online ordering system. Software is another product that could be
developed and distributed in a more modular manner. Object-oriented operating systems like
Unix are already highly modular. Java was designed as a system in which small functional
applets are downloaded and run (and then discarded) only when needed by the user. Even the
design of popular office applications like Microsoft Word and Excel makes them highly
customizable by the user. It is possible that such programs' features could be marketed
separately to consumers who could buy a base system with only those add-ins and features
that they expect to use.11 Later they could simply purchase and download
another component if they decide they need it.
Another possibility is that manufacturing and distribution systems for products which
are semi-modular, or otherwise highly amenable to customization could be redesigned to
integrate the Internet. For example, automobiles are sold with added "options"
which are installed at the factory or at the dealer. An Internet system could make this
process much more efficient for both the automobile firms and the consumer. Other
technologically complex goods could be reengineered to be more modular and customizable,
and the ordering system directly linked to production. Moreover, entirely new approaches
to product design could take advantage of Internet-based ecommerce. But whatever the
future possibilities at the product end of the process, it is clear that the Internet has
immense implications for both the manufacturing process, the final distribution process,
and supply chain relations between firms.
In any economy the total sales in the value chain preceding the consumer far exceed
final sales, so even small efficiencies generated in interfirm trade can have a massive
impact on the macroeconomy. The introduction of a powerful new communication system such
as the Internet creates many opportunities for innovation. In effect, the Internet has the
potential to dramatically lower transaction costs and develop new ways to manage the
supplier chain. The opportunities for cost savings are enormous. The costs of interfirm
transactions in the U.S. alone are estimated to be approximately $250 billion or close to
5% of total GDP, and much of that is simply the overhead associated with the processing of
paper documents (Kershner and Geraghty 1997).
The effort to move interfirm billing and production logistics to electronic media did
not begin with the Internet. However, earlier efforts were idiosyncratic to particular
firms and industries. The generalization of the Internet and its various protocols creates
the possibility of developing one language for all interfirm data communications. Some
firms are already developing what they term e-forms to standardize and facilitate online
interfirm transactions. This is a logical step because the paper documentation is simply
the physical embodiment of information to be transferred from one computer to another.
With the computerization of the entire logistics and distribution functions of an
increasing number of firms, the stage is set to use the Internet to interconnect firms and
eliminate the human and paper intermediates. Moreover, these systems can be interconnected
with marketing and retail functions making the production system highly responsive to
fluctuations in demand. This is underway today and its completion will create the base
upon which to build even more sophisticated systems.
A web site need not be simply for sales information provision, it can also be used to
solicit bids for supplies. This works especially well for goods that are highly
standardized or can be described in great detail through online specifications. General
Electric is the leader in transferring standardized purchases to the Internet. By early
1998 it was purchasing $5 billion of supplies per year through an online bidding process.
The immediate savings from transferring the entire purchasing process online are
substantial, but not fully quantifiable. However, an important indicator is the fact that
it typically costs $50 to process a paper purchase order but only $5 in electronic form
(Smart 1996). Another benefit is that posting the requests for proposals allows suppliers
not previously having relations with GE or with relations to other GE divisions to
respond. For both GE and the supplier there is a significant reduction in information
search costs. The benefit to GE is now it can secure lower-cost goods. The routine
purchase of standardized goods is often largely price-based (given that quality is the
same) and thus the parameters of variation are minimal making ideal for purchase through
the Internet. Naturally GEs success in using the Internet is encouraging (forcing)
competitors to follow suit and is an example to firms in other industries.
The Internet will have significant impacts on the nature of interfirm relations. As an
increasing number of inputs are purchased through the Internet, there should be a
reduction in the role of corporate purchasing agents, as the bidding will be conducted
electronically. The costs of searching for suppliers and customers are being dramatically
decreased, thus lowering transaction costs. Automation of purchasing and other interfirm
links is only at its earliest stages. Thus far changes have centered on lowering costs.
First Mover Advantage
Competitiveness in Internet commerce appears at this time to have many of the
characteristics described by the new institutional economists, such as David (1986),
Arthur (1994), and Nelson and Winter (1982) of being path dependent, increasing returns,
and evolutionary. One outcome of these characteristics is that first-mover advantages are
enormous and the occupation of a niche is critical. Conversely, the capture of
"mindshare" provides a powerful advantage and it is difficult to dislodge an
entrenched competitor using the same business model. There are exceptions to this rule.
For example, Microsoft has been able to dislodge Netscapes lock on Browser software
through the use of its control of the PC operating system.
Amazon developed powerful first-mover advantages in book sales over the Internet, when
it quickly occupied this space and gained mindshare making it difficult to dislodge.
Establishing a web site address in users minds and delivering excellent service can
dramatically insulate the first-mover from competition. Here, a critical feature of
competition is the speed of "Internet time," which compresses years of building
brand name and distribution networks into months. On the Internet a six-month lead is an
extremely powerful advantage.
The establishment of a powerful web site presence can be used either as a portal to
other sites or as in the case of Amazon, which is using its dominance of on-line book
sales to enter music CD sales with positive results even though there are entrenched
rivals. The impact of Amazons entry is not yet clear, but what is apparent is that
it would have been difficult for a startup to enter the online music CD sales segment.
Alternatively, it might be possible for a firm with powerful complementary assets to enter
and either capture the Amazon.com market space or create a new market space in the overall
market space. Here, the new entrant should have sustainable advantages such as special
knowledge, technology, or some other leverage permitting it to outflank or avoid
The global aspects of the Internet are obvious, but books have the national linguistic
dimension that forms a barrier to a unified global bookseller. Amazon.com has recognized
this and purchased the UKs Bookpages (www.bookpages.co.uk) and Germanys
Telebook (www.telebuch.de), both of which are on online book retailers. These startups
provide Amazon with an entrée into these large markets and allow Amazon to take their
lists global. This should help Amazon consolidate its control over the entire book
category. Amazon also purchased the UK-based Internet Movie Database (www.imdb.com) increasing its power in the video
marketplace. In effect, Amazons use of its greater size, access to capital, and
global first-mover advantages allowed it to purchase entrée into these markets. Notice,
that the entrepreneurs who began these businesses were rewarded for their work as the
total size of the deals was $55 million, while Amazon ensured that it would have presence
in Europe and gain the local knowledge necessary to succeed in those markets (Amazon.com
The Internet is global in reach. This means that first-mover firms occupying a
commercial niche in one nation such as online book retailing will have important
advantages in the global economy because the Internet suffers no cost penalty for
distance. The establishment of global freight delivery firms simplifies logistic
dramatically, again decreasing temporal and cost distance. As a result, late-movers
wherever they are located may be excluded from not only the global market, but even their
domestic market, by the global first-mover. Still, despite the fact that the Internet has
a tendency to dissolve international boundaries, it still might be feasible, for example,
to establish online book sales web sites in non-English speaking countries. However, it is
also likely these will have difficulties in long-term competition with larger sites such
as Amazon, though if there is a shakeout, it might occur through mergers rather than
failure. In such a case the entrepreneurs would be rewarded for their establishment of the
website. In effect, the local first-mover would be rewarded by the global first-mover.
We have shown that in economic terms the Internet is more than just another
technological tool. By enabling certain types of activities, the Internet will impact
consumer behavior, firm behavior, and industrial organization. The final configuration
caused by the internet is difficult to predict. This is because the basic impacts of the
Internet interact in problematic and contradictory ways. The most problematic question
related to the economic impacts of the Internet regards market niche and firm formation.
Will the Internet encourage the development of a vast collection of business types,
marketing strategies, and market niches? Or will it lead to a small collection of mega
marketers (such as portals), each dominating a particular product or service? There are
arguments to be made in favor of both possibilities.
At the most abstract level, the Internet can be conceptualized as a giant machine for
reducing transaction costs. As we have seen the Internet is being used in a myriad of ways
to speed, simplify, and enhance relations between consumers and firms. The Internet
reduces physical and bureaucratic drag by drastically reducing the importance of location
and the number of procedural steps requiring the direct intervention of firm operatives.
For example, on the retail side the external costs associated with opening, maintaining,
and staffing actual physical stores is reduced, and on the production/distribution side
the time-related costs of generating and circulating paper is reduced. Startup costs are
also greatly reduced in that all anyone really needs to begin selling things over the
Internet is a connected server, or space on someone else's server. This has led to a
proliferation of individuals and firms attempting to use the Web for commercial purposes.
The ease with which someone can have a presence on the Internet, or access the
Internet, has led to a vexatious paradox. The Internet replaces physical space with a
virtual space within which all places are essentially the same. There are no permanently
situated, highly trafficked intersections or malls with thousands of potential customers
constantly passing by, costs associated with traveling across town to find a particular
product or service, high real estate costs, and parking lots to build. To the customer the
Web is a million places, all in the same place. To the merchant, it is a cacophony within
which being noticed is increasingly difficult. While it is supremely easy to set up a web
site, whether anyone actually visits it is another question altogether. Thus it is likely
that the number of small merchants using the web to market specialized goods and services
will continue to proliferate, and that this proliferation will lead to many successes, but
even more failures. Yet it is also equally plausible to assume that at least in the
mass-market sphere, a small number of firms, either new first movers, or already
established brand names, will dominate their respective product markets at a minimum
nationally and likely globally.
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1. For a history of the creation of the ARPANet, the precursor to
the Internet see, Hauben and Hauben (1998). For the privatization of the Internet and the
creation of the World Wide Web see Reid (1997).
2. The Internet is having profound effects on social norms and
culture (Dery 1996; Slouka 1995; Turkle 1997). It has influenced everything from the way
people access government information and manage their bank accounts to the facilitation of
conspiracy mongering and teenage gossip.
3. The etymological roots of the words "communication"
and "community" indicate the relationship between these two words. Ones
community is with whom one communicates.
4. Much has been made by "old-line" journalistic
sources of the fact that anyone can disseminate information over the Internet, reaching an
audience potentially in the millions. A piece presented on "60 Minutes" cited
the existence of numerous web sites covering such things as UFO conspiracies, theories
about what caused the TWA disaster, and Neo-Nazi beliefs, all of which are not held to any
standard of accuracy. What these critics fail to understand is the Internet is a vast
collection of sites and that the user generally has to seek out the information he is
interested in. Most of these sites will never be seen by most net users. The
"market" for crackpot journalism existed prior to the Internet and it is
unlikely that the Internet will cause it to grow at any appreciable level. To the
contrary, those brands which have a reputation for accuracy and utility will thrive, while
marginal sites will stay marginal.
5. As more automobiles are transformed into mobile offices, it
will be possible through mobile phones to access Internet maps to be downloaded to a
notebook computer, or to an onboard travel computer.
6. Traditionally the travel agent retained 10 percent of the
ticket cost. In late 1997 the airlines cut the cost to 8 percent or $50, whichever was
7. This experiential aspect of the shopping mall, or other types
of shopping experiences, makes it unlikely that Internet shopping will replace malls,
although it is possible that it could erode some mall sales. This is especially the case
in that movie multiplexes have emerged as important mall anchoring tenants. The Internet
will never be able to provide the same social and entertainment experiences as malls.
8. It is an easy matter to change the default home page setting
on browsers but most users either do not know how or do not care to.
9. A new twist in this saga is America Onlines proposed
purchase of Netscape in December 1998.
10. It should be pointed out that the PC direct marketing does
have its limits. Dell and Gateway's main market consists of corporate, government, and
education accounts. This customer base is somewhat experienced and sophisticated about
ordering computers from a distance. Many individual consumers, however, are less
comfortable ordering a PC over the phone or the Internet and past attempts to broaden the
customer base to have been only marginally successful at best. Despite both the amount and
quality of information available on retail web sites, some customers prefer to see and
touch the potential purchase. Moreover, many potential first-time PC buyers don't yet have
Internet access. Gateway is currently making another attempt at broadening its customer
base by establishing chain of retail "stores," located in malls and other high
traffic locations, at which customers can view Gateway computers first hand and then
submit their order at the store, or later from home (Bigelow 1998).
11. Software producers such as Microsoft would prefer that
consumers simply buy all the available add-ins and features in one complete package, even
though many users will never use all of them.