Impact of the Internet on Intermediaries

By

Anurag Mehra M.B.A (1990), University of Delhi B.Tech. (1988), Indian Institute of Technology, Delhi

SUBMITTED TO THE DEPARTMENT OF CIVIL & ENVIRONMENTAL ENGINEERING (CENTER FOR TRANSPORTATION STUDIES) IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF ENGINEERING IN LOGISTICS

at the

MASSACHUSETTS INSTITUTE OF TECHNOLOGY June 1999

@ 1999 Anurag Mehra, All Rights Reserved

The author hereby grants to MIT permission to reproduce and distribute publicly paper and electronic copies of this thesis document in whole or in part

Signature of the Author ...... Uv...... Depa ment of Civil & Environmental Engineering Center for Transportation Studies May 7, 1999

C ertified b y ...... Yossi Sheffi Director, MIT enter for Transportation Studies Thesis Supervisor

Accepted by ...... W hittle

Chair, Departmental Committee on Graduate Studies

MASSACHUS Impact of the Internet on Intermediaries

by Anurag Mehra

Submitted to the Department of Civil & Environmental Engineering In partial fulfillment of the requirements for the Degree of Master of Engineering in Logistics

Abstract

The exponential growth of the Internet has led to the growing debate about "disintermediation, i.e. the elimination of intermediaries from markets. Many believe that traditional intermediaries will soon become extinct because the Internet allows producers to sell directly to consumers in a more cost-effective way. The debate on disintermediation in the literature has so far focussed only on "elimination" of intermediaries, which assumes that all the functions performed by intermediaries can be disintermediated by the Internet. A deeper analysis of the raison d'etre of intermediaries suggests that "elimination" of intermediaries is an extremely unlikely scenario. Broadly speaking, intermediaries perform three functions in a marketing channel: information & transaction function, logistics function and trust function. Clearly, the Internet can impact only the information and transaction function, while the logistics and trust issues still need to be addressed.

This thesis explores the issue of disintermediation from a different perspective: how the Internet will lead to reorganization of intermediary functions and what kind of disintermediation scenarios may emerge. It assumes that the allocation of different functions among various entities in a channel (manufacturers, intermediaries and consumers) will depend on who can perform the function more efficiently in the long run. Based on this premise, the thesis explores various disintermediation scenarios and their applicability to different industries in relation to the consumer needs and buying behavior.

The thesis develops a framework in terms of a decision flowchart that can be used to evaluate the possibility of different disintermediation scenarios for specific products/ industries. The framework fulfills the twin objectives of integrating the different approaches on distribution channels found in the literature and providing a starting point for further research on industry-wise impact of the Internet on channel structure.

Thesis supervisor: Yossi Sheffi Title: Director, MIT Center for Transportation Studies 3

To my parents, my wife Ekta and our newly born son Anirudh 4

Acknowledgements

I would like to thank Prof. Yossi Sheffi for his guidance, encouragement and thoughtful criticism during the entire duration of my thesis work. Our 'weekly meetings', without which it may have been impossible to finish this thesis in this short duration of time, tremendously helped me in focussing on the key issues of this thesis. I am also grateful to Mr. Jonathan Byrnes for his constructive feedback on the first draft of this thesis. 5

Table of Contents

1 IN TR O D U C TION :...... 6

2 CON TEX T A N D LITERA TU RE R EV IEW :...... 11

2.1 COST OF INTERM EDIATION:...... 11

2.2 D IRECT CHANNELS: ...... 12

2.3 INDIRECT CHANNELS: ...... -...... 15 2.3.1 Role of intermediaries: ...... 15 2.3.2 Channel Structure:...... 17

2.4 IM PACT OF THE INTERNET: ...... 27

3 RESEA R CH HY PO TH ESIS:...... 32

4 RESTRUCTURING OF INTERMEDIARY FUNCTIONS: ...... 36

4.1 INFORM ATION INTERM EDIARIES ...... 36

4.2 LOGISTICS INTERMEDIARIES ...... 39

4.3 V ALUE-ADDED INTERMEDIARIES ...... 40

5 DEVELOPING AN INTEGRATED FRAMEWORK: ...... 42

5.1 KEY FACTORS AFFECTING DISTRIBUTION CHANNEL STRUCTURE ...... 43

5.2 IM PACT OF THE INTERNET & 3PL SERVICES: ...... 48

5.3 CONSUMER BUYING BEHAVIOR ...... 50

5.4 D ECISION FLOW CHART ...... - -...... ---.--...... --...... 54

6 EX PLO RA TO R Y A N A LY SIS:...... 59

6.1 (D IS)INTERM EDIATION SCENARIOS: ...... 59

6.2 CASE STUDIES:...... --.-...... 75 6.2.1 Books: ...... 75 6.2.2 Computers:...... 79

6.3 LIM ITATIONS OF EXPLORATORY ANALYSIS:...... 84

7 CON C LU SIO N :...... 85

7.1 THESIS FINDINGS: ...... - .-...... -... ---...... 85

7.2 FUTURE RESEARCH: ...... --.-.. --...... 86

8 REFER EN C ES:...... -----...... - --. . --...... 88 6

1 Introduction:

Rapid technological progress in information and communication technologies along with their widespread diffusion have led to speculation about "frictionless" economies in which transaction costs are nearly zero, barriers to entry disappear, and markets clear instantly. Some think that electronic commerce, with producers selling directly to consumers over computer networks such as the Internet, will eliminate existing intermediaries ("disintermediation") and drastically reduce transaction costs (OECD, 1998).

Transaction costs:

The work done by Ronald H. Coase in introducing the concept of transaction costs in understanding why firms exist in the form and size that they are, is perhaps more relevant now than ever. In his article "The Nature of the Firm" (published in 1937, for which he received the Nobel Prize in Economics in 1991), he addressed the following basic question (Coase, 1992):

"Why do firms exist, if the pricing mechanism (Adam Smith's 'invisible hand') can do all the coordination necessary for markets to work?"

Coase found that the answer lies in transaction costs. He realized that there were costs involved in using the price mechanism: costs related to negotiations, contracts, inspections, dispute settlements etc. It was the avoidance of the costs of carrying out transactions through the market that could explain the existence of firms in which allocation of factors came about by administrative decisions rather than price mechanism. Hence, Coase argued that a firm would grow in size up to a point when the cost of internal coordination exceeds the cost of market transactions. Similarly, a firm would outsource an activity or a function if the transaction cost were lower than internal coordination cost. 7

The role of intermediaries in a market can be explained in terms of reduction in transaction costs. For a firm trying to sell directly to its customers, the cost of communication, distribution and servicing may be quite large if the customers are geographically spread out and buy in small quantities. Intermediaries reduce this cost by providing aggregation and dis-aggregation services. The explosive growth of the Internet has now provided manufacturers/ sellers a low cost access to consumers. So the following question arises:

"Why should intermediaries exist, when the Internet allows (by reducing transaction costs) sellers and buyers to transact directly through the pricing mechanism?

The growing phenomenon of online auctions is evidence of the disintermediation possibility. So is the online success of organizations like Amazon.com and Dell. A potentially larger impact involves the displacement of intermediaries whose basic function is to convey information that is asymmetrically possessed, for example by travel agents, insurance agents, stockbrokers, real estate agents, etc. There is evidence of decline in commissions of stock traders by as much as 57% and of travel agents by 43% (OECD, 1998). Similarly, for products that can be digitized (e.g. software, music & video), traditional intermediaries will face much greater prospects of disintermediation than other industries. For instance, software distributor Egghead (www.egghead.com) closed over eighty traditional outlets to become the first retailer to make the transition to Internet-only retail model (BusinessWire, 1998).

However, there is evidence to the contrary too. Bailey and Bakos (1997) explored thirteen case studies of firms participating in electronic commerce and found that new roles arise for electronic intermediaries that seem to outweigh any trends toward disintermediation. A quick look at the top ten shopping sites on the Internet gives some interesting insight. According to Media Metrix (www.mediametrix.com), an Internet and 8

Digital Media measurement company, the top ten shopping sites (as of Feb, 1999) with visitors ranging from 2-12 million per month are:

1. www.bluemountainarts.com 2. www.aol.com 3. www.amazon.com 4. www.eBay.com 5. www.cnet.com 6. www.barnesandnoble.com 7. www.cdnow.com 8. www.columbiahouse.com 9. www.musicblvd.com 10. www.valupage.com

Interestingly, none of these sites belong to a manufacturer. Amazon.com's success is often quoted as evidence of the growing disintermediation phenomenon. However, the reality is just the opposite. Amazon.com is just another intermediary, albeit not of the traditional kind. This confusion arises because people generally fail to make a distinction between the following two questions:

1. Is a product suitablefor online sales (i.e. will the consumers buy over the Net)? 2. Is a product suitablefor direct (manufacturerto consumer) online sales?

Clearly, books are very well suited for online sales, but it does not imply that publishers will start selling directly to consumers. In the case of Amazon, it is like a wholesaler selling directly to the consumers on the Net, and therefore disintermediating the retailers.

Research areas:

Since electronic commerce is still at a very early stage in its development, much of the thinking in this area is based on speculation or anecdotal evidence. As with the advent of 9 any new technology that may be widely diffused, there are overly optimistic and pessimistic predictions, which are generally inaccurate (mail order has not displaced traditional retail trade and the VCR has not displaced teachers). To correctly understand the impact of electronic commerce on markets and economies, research is required in every aspect of e-commerce. Some of the research areas identified by OECD (1998) are:

1. A statistical methodology and apparatus for measuring electronic commerce should be developed.

2. The economy-wide and sector-specific impact of e-commerce on productivity should be assessed, and the notion that this application may lead to a sustained higher level of economic efficiency should be explored.

3. Monitoring of the restructuring of intermediary functions is needed.

4. Sectoral studies on a variety of consumer and business products should be undertaken to measure the impact and identify factors that encourage and inhibit price competition, including the use of intelligent agents. The impact of the structure of price setting and of the frequency of price changes on markets and on measurement also requires study.

5. The electronic marketplace needs to be continuously monitored. Case studies should address the sectoral and market specificity of organizational impacts. Ongoing assessment of potential new barriers to market entry is also needed.

Focus of the thesis:

This thesis addresses the third issue identified above, i.e. the impact of electronic commerce on the structure and form of intermediaries and analysis of sectoral differences in "disintermediation". 10

In order to assess the impact of Internet on intermediaries in a specific industry, it is important to analyze the following:

1. From manufacturer's perspective, the cost tradeoffs involved in going direct vs. going via intermediaries. 2. The raison d'8tre of intermediaries in that industry, i.e. what economic value is added by the intermediaries. Value addition may be in non-monetary forms like risk- mitigation. 3. Consumer needs, expectations and buying behavior.

This research being exploratory in nature, does not go into industry-specific cost structures. The other issues related to the role of intermediaries and the relevance of consumer buying behavior to channel structure are discussed in greater detail.

Specifically, this research aims to answer the following questions:

1) What are the product/ market characteristics and other variables that have an impact on the structure of distribution channels and existence of intermediaries? 2) What is the impact of the Internet on these variables and therefore on channel structure for different industries? 3) If disintermediation is a possibility, what kind of disintermediation may occur? Will wholesalers be impacted more or retailers? Will traditional intermediaries transform into cyber-intermediaries? 11

2 Context and Literature Review:

This chapter examines the role of intermediaries and their raison d'etre in distribution channels. Section 2.1 describes the cost added by intermediaries to explain why disintermediation is such a big issue in e-commerce. Section 2.2 examines why direct search markets have remained a small niche so far and how the Internet is changing the tradeoffs in direct vs. intermediated markets. Section 2.3 describes the role of intermediaries and various theories of distribution channel structure found in the literature. Section 2.4 examines the disruptive power of the Internet and why it may lead to disintermediation.

2.1 Cost of intermediation:

In the chain of activity between the final producer and the final consumer, intermediaries generally perform three services - transportation, wholesaling, and retailing. In most OECD countries, intermediaries typically add about 33 per cent to the final price of goods. In the United States, for all personal consumer expenditures (PCE) (goods and services), intermediaries add about 15.6 percent to the final price, of which 0.6 per cent represents transportation, 3.8 percent wholesale costs, and 11.2 percent retail costs (OECD, 1998). In some cases, the cost added by intermediaries may be as high as 62% as illustrated for high-quality shirts market (Benjamin and Wigand, 1995): 12

Cost per Percent A. Thie Variants of Altemate Value Added :i1aum

1. Producer Wholesaler ---- > Retailer Consumer* $52.72 0%

2. Producer Wholesaler Retailer Consumer* $41.34 28%

3. Producer Wholesaler Retailer Consumer* $20.45 62%

B. Growth in Value Added ard Selling Price

Producer Wholesaler Retailer Consumer* Value Added $20.45 $11.36 $20,91 Selling Price $20.45 $31.81 $52.72 $52.72

* Consumer transaction costs are not consid ered.

The above example illustrates how disintermediation (of retailer, wholesaler or any other intermediary between the producer and the consumer) can save substantial costs for manufacturers and (ultimately) consumers. It is not surprising therefore that some forms of direct channels exist in the economy.

2.2 Direct channels:

Not all markets require intermediaries to function. Garbade (1982) classifies market- based coordination into four categories:

1. Direct-search markets (where buyers and sellers seek out one another). 2. Brokered markets (where brokers assume the search function). 3. Dealer markets (where dealers hold inventory against which they buy or sell). 4. Auction markets (where buyers and sellers meet to bid for goods on sale).

Except for the first category of markets, all other types of markets depend on intermediaries to facilitate market transactions. Direct search markets have traditionally been limited in their appeal due to the high cost of searching buyers or sellers, even though there may be some savings in distribution costs. Generally, there is a tradeoff 13 between high search costs of direct channel and high distribution costs of indirect channel:

Direct channel Indirect channel High search High distribution costs costs

Data from the 1992 Census of Retail Trade shows that non-store retailers (SIC code 596) accounted for 51 billion dollar of sales, which is only about 2.7% of the total retail sales ($1.9 trillion). Out of this, catalog and mail-order houses accounted for 34 billion dollars of sales. According to the Direct Marketing Association (www.the-dma.org), consumer catalogue sales in 1998 was about $53 billion (out of total catalog sales of about $87 billion, and total retail sales of $2.7 trillion), generated by an estimated 12 billion catalogues mailed to consumers, at a cost of about 70 cents each (New York Times, 1998). With such high costs, it is not surprising that catalog marketing has remained a small segment of total retail market. However, this picture is now dramatically changing because the marginal cost of reaching customers directly on the Internet is negligible compared to the mail-order catalog:

Internet

Direct channel Indirect channel High search High distribution costs costs

The Internet, as a direct marketing channel not only has many similarities with mail-order catalog business but also has the potential to combine the best of catalog and TV-based shopping, while adding unique advantages like interactivity (Goldman Sachs, 1997). 14

Companies can, in fact, do things with web that may have been impossible in catalogues due to production costs and space limitations. For example, Crutchfield (www.crutchfield.com) has a vehicle selection chart where shoppers type the year, make, model, and body type of their vehicle into the interactive Vehicle Selector, and the site automatically customizes all subsequent pages to feature only components that will work in that car. The Internet also allows catalogers to tailor pricing on a daily basis in response to consumer demand, making them less vulnerable to excess inventory and markdown concerns. Hence, the Internet has taken catalog business to a much higher level of sophistication that can be exploited by savvy marketers to increase their revenues and profitability. The importance of catalog sales in retailers e-commerce strategy is evident in the tender offer (source: Bear Stearns Equity Research, 1998) made by Federated Department Stores (owners of brand names like Macy's and Bloomingdale's) for 100% of Fingerhut (2 "dlargest cataloger in U.S.) shares for a deal valued at $1.7 billion.

W.A.Dean & Associates, a catalogue industry consulting company estimates that more than half of the consumer cataloguers currently have e-commerce sites (New York times, 1998). Catalog Age (www.catalogagemag.com) ranking of the top 100 US catalog companies also gives an indication of how these two businesses are merging. The revenue of 10 computer-only catalogers ($27 billion) accounts for more than 45% of total catalog sales ($60 billion) in 1997. Leading the pack in computer-only catalogers are of course Dell ($11.9 billion) and Gateway ($6.3 billion), who earn a substantial portion of their revenues through Internet sales.

So it appears that the Internet holds a lot of promise for direct marketers like catalogers, but its impact on traditional channels of distribution is not so clear. As discussed earlier, there is mixed evidence of disintermediation and reintermediation, depending on the changing role of the intermediaries. 15

2.3 Indirect channels:

2.3.1 Role of intermediaries:

Several roles of intermediaries have been identified in the literature. Malone, Yates and Benjamin (1989) identify the following reasons for existence of intermediaries:

1. Aggregate buyers' demand or sellers' products. 2. Build trust between buyers and sellers. 3. Facilitate the market by reducing transaction costs. 4. Match buyers and sellers.

All the functions mentioned above have one common objective: improving the efficiency and efficacy of the channel. Sarkar, Butler & Steinfield (1998) suggest a broader list of functions performed by intermediaries, dividing them into two categories:

1. Services to consumers:

Search and Evaluation. Retail intermediaries design the type of the search and evaluation services that will be offered to consumers by choosing the product mix and focus. A consumer choosing a specialty store over a department store implicitly chooses between two alternative search and evaluation criteria.

Needs Assessment and Product Matching. In many cases it is not reasonable to assume that individual consumers possess the knowledge needed to assess their needs reliably and identify the products which will efficiently meet those needs. Therefore, intermediaries can provide a valuable service by helping customers determine their needs. 16

Customer Risk Management. Consumers do not always have perfect information, and hence they may purchase products that do not meet their needs. Consequently, in any retail transaction the consumer faces a certain amount of risk. By providing consumers with the option to return faulty products or providing additional warranties, intermediaries reduce the consumers' exposure to the risk associated with producer or communication error.

Product Distribution. Many intermediaries play an important role in the production, packaging, and distribution of goods. Distribution service firms, such as Federal Express, are a prime example of how information technology has begun to make it economical to independently provide services that historically have been provided by integrated retail intermediaries.

2. Services to producers:

In addition to providing services for consumers, intermediaries also provide a variety of services for producers. In choosing marketing channels, producers choose the bundle of services provided by the intermediaries involved. Several functions of intermediaries purchased by producers are briefly highlighted below.

Product Information Dissemination. Intermediaries provide service to producers by informing consumers about the existence and characteristics of products. In some cases, such as traditional retail intermediaries, these information services are tightly tied to other services, such as distribution, and in other cases the information services and distribution may be provided by independent intermediaries.

Purchase Influence. Ultimately producers are not interested only in providing information for consumers; they are interested in selling products. Thus, in addition to information services, producers also value services related to influencing consumer purchase choices. Intermediaries can influence consumers' purchasing behavior by strategic product placement, explicit advice from sales agents etc. 17

Provision of Customer Information. Intermediaries also provide valuable information about customers to producers, that is used by producers to evaluate new products and plan production of existing products.

Producer Risk Management. Like consumers, producers face risks when engaging in commercial transactions. Intermediaries provide services that enable producers to manage their exposure to such risks as inventory risks, consumer fraud and risk associated with consumer and producer error.

Transaction Economies of Scale. As with production of goods, transaction services (e.g. order aggregation) provided by intermediaries are subject to economies of scale, which are often achieved through the use of IT. Also economies of scale in transportation allow intermediaries to reduce the total cost of distribution for the channel.

Integration of Consumer and Producer Needs. Intermediaries must deal with problems that arise when consumer needs conflict with the needs of producers. In a competitive environment an intermediary must provide a bundle of services that balances the needs of consumers and producers and is acceptable to both. For example, a producer may wish to inform consumers about the existence of a good while consumers may not wish to receive it & would rather have it filtered out as part of the product search and evaluation process.

2.3.2 Channel Structure:

A channel of distribution can be considered to comprise a set of institutions which performs all the activities (or functions) utilized to move a product and its title from production to consumption (Bucklin, 1966). A typical distribution channel may look like the following:

Manufacturer Intermediary 1 Intermediary2 Consumer 18

Where, intermediaryl may be a wholesaler/ distributor and intermediary2 may be a retailer. Hence, a channel may be defined in terms of the following three variables related to the intermediaries:

1. Levels of intermediaries (number of echelons in the channel). 2. Number of intermediaries in each level. 3. Exclusivity of intermediaries (eg. geographic coverage).

A normative channel is generally defined in the literature as a set of institutions which, in the long run, and under conditions of competition and low barriers to entry, constitutes the channel for a product. The purpose of defining such a channel is to understand the basic forces that control channel structure and to develop a benchmark against which real world channel structures may be meaningfully compared.

The real world channel may be different from the normative channel because of two reasons. First, many barriers prevent the realization of the full effect of competitive forces, and second, the normative channel is a long run concept- an equilibrium that may never be realized because of continuous technological and social changes. The Internet has, in no small measure, contributed to the dizzying pace of change that firms face today. Hence, in today's environment, the concept of normative channels may be a purely theoretical construct, but still worthy of study for the insights it can provide on what the future may hold for distribution channels.

Most of the marketing literature on distribution channels focuses on normative channels. Four different approaches have appeared in the literature in development of theory of distribution channel structure (Frazier, 1987):

1. Bucklin (1966): theory of distribution channel structure. 2. Mallen (1973): functional spin-off approach. 3. Williamson (1979): transaction cost approach. 4. Anderson & Weitz (1983): scale economies approach. 19

Bucklin (1966) relates the structure of distribution channels with the functions performed by all the organization entities involved in the channel flows, including the consumer. He identifies five categories of activities/ functions:

1. Communication function: consisting of all activities that serve to transmit to prospective buyers or sellers information concerning offers to buy or sell and the acceptance of these offers. 2. Ownership function: concerned with activities that surround the holding of title to goods. 3. Inventory function: includes all activities that physically control the product at a given location, not including the capital or risk charges incurred by storage, that being part of the ownership function. 4. Transit function: includes all activities that physically transport goods between locations. 5. Production function: consists of all activities that create the product or commodity.

The way Bucklin relates these functions to the channel structure is as follows:

Consumer Channel Functional Channel Demand for Outputs structure structure channel outputs

The channel outputs are defined in terms of three variables:

1) market concentration 2) delivery time 3) Lot size

Market concentration concerns the size distribution of customers a firm faces as well as their geographic density. The more concentrated a market, the more feasible is a "direct" channel because costs of serving such a market would be lower by direct or shorter 20 channel. Similarly, the more customer service required by the customers (in terms of faster delivery times and smaller lot sizes), the less desirable is a "direct" channel.

Direct channel

Cost Indirect channel

Services Direct Indirect

The cost of providing increasing level of services to consumers generally increases more rapidly for direct channels than for indirect channels. On the other hand, at low level of service, indirect channels are likely to be costlier than direct channels because of the fixed costs associated with the intermediary functions. Hence, there generally exists a breakeven point below which direct channels are more efficient and above which indirect channels.

So the basic construct of Bucklin's theory of distribution channel structure is that consumers determine the desired channel output, which in turn determines the division of functions among various organizational entities (including the consumer) and therefore eventually the channel structure based on the long-run efficiency of different channel types. Alderson (1957) supports this argument by contending that the efficiency of vertical market structures is improved by the performance of two functions by intermediaries: matching and sorting.

Based on the above theory, Bucklin, Ramaswamy & Majumdar (1996) propose the following hypotheses: 21

1. In markets where end-users buy in small quantities, indirect channels are more likely to prevail. 2. In markets where goods must travel great distances to reach the end-user, indirect channels are more likely to prevail. 3. Under market conditions characterized by end-users who purchase frequently, indirect channels are more likely to prevail. 4. Under market conditions characterized by manufacturers who produce narrow assortments, indirect channels are more likely to prevail. 5. In markets where product customization is critical to end users, direct channel structures are more likely to prevail. 6. In markets characterizedby intense product or technological activity, direct channels are more likely to prevail. 7. In markets characterized by rapid technological change, direct channels are more likely to prevail. 8. In markets characterizedby higher customer concentration, direct channels are more likely to prevail.

It is interesting to note the relevance of hypothesis no. 6-8 to the computer industry and how these have been successfully leveraged by Dell (www.dell.com) for its direct model. A more detailed discussion of Dell's model is covered in Section 6.2.

Bucklin also developed a framework in which the generic classification of goods given by Copeland (1923) is related to the distribution channel structure (Bucklin, 1963). It suggests that for convenience goods (e.g. groceries), an indirect channel is more suited, while for shopping goods (e.g. consumer electronics), a direct channel may be more desirable. This conclusion can be derived from the theory described above, since for shopping goods, consumers are probably willing to wait to get exactly what they want, while for convenience goods, consumers require higher service (faster gratification) and are therefore better off picking the goods from the nearest retail outlet rather than wait. 22

Catalog marketers have traditionally used this classification to sell goods that consumers want and are willing to wait for. The only problem with catalog marketing has been the fact that the communication between the sellers and the buyers is essentially a one-way process, i.e. from the sellers to the buyers. Although catalog sellers rely on extensive market research to determine the type of goods desired by the consumers, and consumers also have a choice of selection and ordering, broadly speaking catalog marketing has remained a uni-directional marketing process. However with the ubiquity of the Tnternet, this is bound to change. Consumers can now be expected to have a greater say in the selling process in terms of determining the goods they want in the first place. In electronic marketplaces, intermediaries such as www.priceline.com allow buyers to specify product and price requirements and make corresponding offers to participating sellers, reversing the traditional transactional flow of retail/ catalog markets.

Bruce Mallen's (1973) approach is based on the assumption that functions (e.g. delivery, warehousing, selling) will align in the channel based on who (manufacturer, wholesaler, retailer etc.) can do them most efficiently. For example, if a manufacturer finds that the stocking function can be done at much lower cost by a retailer, it will spin-off the function to an independent retailer.

Williamson (1979) developed what is commonly referred to as the "transaction cost analysis" approach. It is the application of the work done by Ronald H. Coase on transaction costs to the institutional framework of distribution channels. According to this approach, firms and consumers try to reduce their transaction costs as much as possible. In this process, intermediaries will be created if there is an opportunity to reduce the transaction costs between sellers and buyers. A key concept in this approach is "asset specificity" which refers to the uniqueness of the assets needed to facilitate product and title flows in the channel. To keep transaction costs low, firms would be better off going direct if the asset specificity were high, especially when high uncertainty exists in the environment. Indirect channels with high asset specificity under conditions of high uncertainty will have high transaction costs, in part because of possible opportunistic 23 behavior of the channel members in possession of the specific assets, and in part because contingent contract are difficult to develop under conditions of high uncertainty.

Transaction cost theory is an often-employed framework in the context of channel structure since it focuses on a firm's choice between internalized, vertically integrated structures, and the use of external market agents for carrying out activities that constitute its value chain. In the context of channel decisions, it can be used to articulate the decision process whereby firms either "make or buy" an intermediary function; that is, whether the firm decides to internalize the channel activity (or sub-activities) within its organizational boundaries, or whether it chooses to rely on the market.

A fourth approach, developed by Anderson and Weitz (1983) and generally referred to as "scale economies" approach, predicts that small manufacturers with limited product line are better off using indirect channels since independent intermediaries can accumulate the products of other manufacturers and therefore incur lower selling costs. Internet has, however, drastically changed the rules of the game for small players. Small manufacturers are no longer inhibited by geographical constraints and potentially have access to the entire global market (subject to the reach of the Internet).

Not much effort has been made in the past to integrate these different approaches or to develop a common framework. Frazier (1987) while identifying this as an important research need, integrates the framework of Bucklin (1966) and Williamson (1979) as follows: Asset specificity = Low Asset specificity = High

Low capital High capital Low capital High capital availability availability availability availability Low M.C Indirect Indirect Indirect Combo High CSR Low M.C Indirect Combo Combo Direct Low CSR High M.C Indirect Direct Combo Direct High CSR High M.C Combo Direct Combo Direct Low CSR 24

Where, M.C = Market concentration, CSR = Customer service requirements, Combo = Mix of direct and indirect channels.

The above table highlights the importance of integrating these different approaches. For instance, it shows that high asset specificity does not always imply direct channels, especially if market concentration is low and service requirements of customers are high. Similarly, high market concentration or low service requirements alone are not sufficient conditions for direct channels.

Besides these four qualitative frameworks, there have been some attempts do develop quantitative models of distribution channels. Balderston (1958) explains the existence of intermediaries by a single variable: contact and communication costs. He contends that every intermediary that cooperates but does not compete, reduces by its presence the total cost of contact and communication in the system. For instance, if m = number of producing firms, n = number of buyers and r = number of intermediaries (say retailers), the number of contacts made in a direct channel will be = m x n; while in an indirect channel it will be = r (m + n). Intermediaries will be drawn into the system (i.e. r will increase) so long as the total contact and communication cost in the channel reduces, allowing them to earn profits. In equilibrium, the number of intermediaries will therefore be equal to:

Number of intermediaries (r) = (m x n)/(m + n)

This, of course, is a highly simplistic view, but can be extended to cover all types of transaction costs, besides cost of contact and communication. Hence retailers, for example, reduce the search, negotiation and contracting costs between manufacturers and consumers by providing a physical market place with assortment of goods produced by different manufacturers. Although, it only explains the existence of middlemen in one level, the logic can be extended further to explain the existence of wholesalers between the manufacturers and retailers. 25

Baligh and Richartz (1967) developed the Balderston model further to estimate the number of levels of intermediaries, besides the number of intermediaries at each level, and the effect of the following variables on the these numbers: i) cost of information transfer ii) fixed cost associated with entry of middlemen iii) market segmentation and product differentiation.

According to their model, the number of intermediaries in equilibrium (as given by Balderston) will be reduced if any of the above factors increase. For example, in a segmented market, all buyers do not contact all sellers. Hence the total cost in a direct channel will be relatively lower, thereby reducing the number of intermediaries possible in equilibrium. Similarly, the higher the fixed cost of entry for an intermediary, the lower would be their number in equilibrium.

Huff (1981) uses central place theory to estimate the size, spacing and number of distribution centers (retailer locations) required to provide goods and services to a dispersed population. The basic premise of his model is that the price of a particular good to a consumer includes not only the retail selling price, but also the travel costs incurred in going to the retail location. If 'm' represents the distance from a consumer's residence to a retail store, and 't' represents the cost for consumer per unit distance, then the total price paid by the consumer = p + mt, where 'p' is the selling price.

Price Price

p + mt ------p + mt ----- ~~-----

Distac P------Quan I Distance IQuantity m q q' 26

The retailer's demand will be a function of the total price for consumers (actual demand q will be less than q', which is the demand retailers would face if there were no travel costs for consumers). The market area of a retail store, given a selling price, can then be represented by a circle with radius proportional to the demand for the store. The more the number of retailers in an unsaturated market, lower will be the cost for consumers. However, if the market is fully covered by existing retailers, additional retail locations will encroach upon each other's market areas, making the size of the circles smaller.

The following table summarizes the various approaches described above and reviews them in the context of the changed scenario of e-commerce:

Approach Key hypothesis Implications for e-commerce developed by Bucklin (1966) The higher the market Geographic market concentration concentration, the better the not much relevant in terms of viability of direct channel transactions, because of the ubiquity of the Internet. In terms of logistics, it is still important. The more the service required by Still relevant. However, the network consumers (smaller lot sizes, created by parcel companies like faster delivery), the lesser the UPS and FedEx has increased the viability of direct channel. feasibility of direct channel even for smaller lot sizes and faster delivery. Bucklin (1966) Indirect channels are more suited Still relevant. However, the Internet /Copeland for convenience goods & direct is bridging the gap by making (1923) channels for shopping goods. comparison-shopping convenient and inexpensive. Bruce Mallen Marketing functions will align in "Core competency" argument still (1973) the channel based on who can do relevant. them more efficiently. Williamson Intermediaries will exist if they Transaction cost of direct marketing (1979) / Coase reduce transaction costs. reduced drastically by the Internet. (1992; 1937) May result in disintermediation of traditional intermediaries and/or creation of new types of intermediaries. Anderson & Small manufacturers are better Small manufacturers may find Weitz (1983) off using indirect channel to take Internet sales more viable than the advantage of economies of indirect channel because of global aggregation. reach of Internet. 27

Balderston Intermediaries exist because they The Internet may wipe out (1958) reduce contact and intermediaries that exist only for this communication costs. reason, by providing a low cost many-to-many communication medium. Baligh & The higher the market The Internet has drastically lowered Richartz (1967) segmentation, product the fixed cost of entry for differentiation and fixed cost of information intermediaries. Hence it entry, the lower the number of will fuel growth of information intermediaries. intermediaries. Huff (1981) Retailers' demand is a function Quite relevant. Direct corollary of of total price to consumers, this theory is that the demand of which is a sum of selling price retailers will reduce because relative and travel cost to retail outlet. inconvenience cost for retail has increased with the availability of convenient online shopping.

2.4 Impact of the Internet:

Downes & Mui (1998) describe the Internet as a "killer app", i.e. a product or service that "winds up displacing unrelated older offerings, destroying and re-creating industries far from their immediate use, and throwing into disarray the complex relationships between business partners, competitors, customers, and regulators of markets."

The impact of the Internet on the channels of distribution has however been addressed only sparsely in the literature, since the Internet phenomenon itself is quite new. Malone, Yates and Benjamin (1989) were among the first to link transaction cost theory to electronic communication, illustrating how electronic markets can lower the cost of transactions and influence the formation of markets. In their view, electronic networks encourage vertical de-integration of firms by lowering the cost of "buying" compared to "making" in-house.

In the context of channel decisions, transaction cost theory can be applied in two ways. Proponents of the threatened intermediaries hypothesis argue that a ubiquitous network (such as the Internet), by extending into consumers' homes, lowers the transaction costs 28 producers incur when marketing directly to end consumers. However, the same transaction cost theory can be used to argue that producers will outsource intermediary functions, resulting in greater reliance on intermediaries.

Sarkar, Butler & Steinfield (1998) resolve this paradox by arguing that four different possibilities exist depending on changes in relative transaction costs:

Before Internet: After Internet:

T2 Intermediary Intermediary

Producer Producer T3* Consumer Ti * Consumer

In the pre-Internet scenario, intermediaries existed if TI was greater than T2 + T3. Similarly, in the post-Internet scenario, intermediaries will exist if T1* > T2* + T3*. The impact of the Internet on intermediaries can therefore be evaluated for four different scenarios:

Before Internet T1T2+T3 T1* < T2* + T3* Internet supplements Threatened W- direct market intermediaries T1* > T2* + T3* Cybermediaries Internet supplements intermediaries

Threatened intermediaries scenario is only one of the four possibilities, happening if Internet flips the relative transaction costs in favor of direct transactions. In other cases, Internet could be supporting existing markets or creating new intermediaries (called cybermediaries). 29

Balasubramanian (1998) analyzes the competition between direct channels like catalog and the Internet, and conventional retail channels, using a circular spatial market model. He establishes a mathematical relationship between the relative cost advantages of direct channels vs. retail channels, and the equilibrium market share that can be established by a direct marketer. His model uses a concept similar to the one introduced by Huff, in terms of the travel cost for consumers being a major component in arriving at the retailer's market share. Based on this model, he derives the following hypotheses:

1. If consumers have complete knowledge of product availability and prices in all channels, the direct marketer acts as a competitive wedge between retail stores. Each retailer competes against the remotely located direct marketer, rather than against neighboring retailers. 2. Direct marketers will participate in a market if consumers' travel cost (including opportunity cost of time spent on retail shopping and implicit cost of convenience) is high and the disutility of buying direct (not so quick gratification, no physical inspection before buying, product returns difficult etc.) is low. 3. Under the assumptions of the model, direct marketer can get a maximum two-third share of the market even if the disutility of buying directfor consumers is zero.

Not much empirical research has been done on estimating the sectoral impact of the Internet on distribution channels. Reliable economy-wide statistics on Internet commerce is itself difficult to find. A recent report entitled "The Emerging Digital Economy" (US Department of Commerce, 1998) analyzes the importance of electronic commerce and information technologies to the economy as a whole and to individual sectors of the economy. Some important highlights are:

" The Internet's pace of adoption has eclipsed all technologies that preceded it. To reach the 50 million users mark, radio took 38 years, TV 13 years, PCs 16 years, and the Internet took just 4 years. " Computing power has been doubling every 18 months for the past 30 years. At the same time, average price of a transistor has fallen by six orders of magnitude. 30 e Traffic on the Internet has been doubling every 100 days. " In 1994, 3 million people used the Internet. In 1998, 100 million people were using the Internet. Some experts believe that by 2005, one billion people may be connected to the Internet. " Analysts predict that business-to-business commerce over the Internet will grow to $300 billion by 2002, still however representing just 3% of the total GDP.

" Digital delivery of news and information saves about 30-40 f tVh toLtl cos oCL newspaper or magazine. " Cost of electronic ticket purchased by a consumer on the Internet is 1/8th the cost of a ticket sold by a travel agent. " It costs about a penny to conduct banking transaction over the Internet, while it takes more than a dollar if handled by a teller at a branch bank. " By a conservative estimate, Internet retailing is expected to reach $7 billion by 2000.

A recent study sponsored by National Retail Federation (E&Y, 1998) highlights some important facets of Internet commerce. Some key observations from the study are quoted below: e Today's online retailers expect the Net to account for a steadily increasing percentage of their revenue, from 1% of total sales today to 9% for fiscal year 2001. Manufacturers already selling online project that the Internet will represent 7% of their total revenue by their fiscal year 2001. " Consumers who are online but don't buy through the Net cite two main reasons: the fear of giving out credit card information and the need to see the product before buying it. " Companies that view the Internet as an 'either-or' proposition are missing the point. Web can be an influential sales channel, but it also can be a powerful medium for driving purchases through more traditional channels. " Why are computers, books, clothing, music, gifts, and consumer electronics among the most popular purchases of online shoppers? It is a function of several things: the demographics of Web buyers; the attributes of products and services they are most 31

comfortable buying through this new medium; and who has been selling the longest on the Web to date. * Who do retailers fear most in cyberspace? None other than the growing number of startup companies whose storefronts exist only in the digital world - companies with no physical investments to protect, no channel relationships to massage, and comparatively less internal corporate politics with which to contend.

* Manufacturers of consumer products got more aggressive about selling direct to consumers through the Internet in 1998, yet the majority still do not sell online today and have no plans to do so in the future - particularly those with annual sales of more than $1 billion.

The impact technology (like the Internet) can have on the traditional business structures is dramatically highlighted by the case of Encyclopaedia Britannica (Evans & Wurster, 1997), which was completely devastated by the advent of CD-ROM encyclopaedia. Since 1990, sales of the Encyclopaedia Britannica multi-volume sets have decreased by more than 50 percent. The reason is simple: it costs in the range of $1500-$2200 to buy the paper version, while an encyclopaedia on CD-ROM, such as Microsoft Encarta, sells for about $50 and customers often get it free because it is bundled with their personal computers as CD-ROMs. Interestingly, the largest part of Britannica's cost structure was not the editorial content, which constituted only about 5 per cent of costs, but the direct sales force. When Britannica realized the threat from CD-ROM encyclopaedias it created a CD-ROM version, but to avoid undercutting its sales force, the company included it free with the printed version and charged anyone buying the CD-ROM alone $1000. Revenues continued to decline, the best salespeople left, and Britannica's owner, a trust controlled by the University of Chicago, finally sold out. Under new management, the company is now trying to rebuild the business around the Internet.

This case highlights the two most important issues in e-commerce: 1. Fundamental changes in business are required to adapt to the new environment. 2. Managing this transition is likely to be painful to the existing players because of the inherent conflict with their existing business. 32

3 Research Hypothesis:

It is clear that the traditional role of intermediaries is now undergoing major transformation. Two factors have been primarily responsible for this:

1. Growth of the Internet. 2. Growth of small parcel logistics services.

These two factors combined have enabled the creation of an alternative marketing channel in which the information service to consumers (or customer interface/ transaction management) is provided by information while logistics service is provided by third party logistics companies (like FedEx).

Before Internet:

Manufacturers 1,Wholesalers Retailers Consumers

After Internet: Information Intermediaries

Manufacturers Wholesalers Retailers Consumers 33

The information intermediaries may be providing information to the consumer by accessing information owned by (or available with) the manufacturer, wholesaler or retailer. Similarly, the logistics service providers may be delivering goods to the consumer after picking directly from the manufacturer, wholesaler or retailer.

It is apparent from the above discussion that there are various (dis)intermediation possibilities depending on which channel structure is more efficient in satisfying consumer needs and at the same time allowing the commercial channel (manufacturers and intermediaries) to make profits in the long run. The normative channel structure may be expected to be different for different industries based on consumer needs, expectations, buying behavior and product characteristics.

The key hypotheses of this thesis are as follows:

HJ: The Internet will lead to a reorganization of vertical markets in terms of the functions performed by various players, instead of complete disintermediation.Multiple (dis)intermediation scenarios may emerge based on which player performs what function.

H2: Traditionalintermediary functions will split into distinctfunctions of information (or transactionmanagement) and logistics. In certain industries, value-added intermediaries will emerge that will support Internet commerce by filling the functional gap of trust and service support.

H3: Growth of information intermediaries will be much faster than other types and its impact on traditional intermediaries will depend on the consumers needs and product characteristics. 34

Logistics Intermediaries

Traditionally, retailers have provided both logistics and information services to consumers; and wholesalers in turn have provided the same to retailers. The logistics services include:

1. Reducing delivery lot size to consumers (they can't buy a truck/ pallet load of an item). 2. Reducing waiting time for consumers (they can pick up goods from retail outlets rather than waiting for delivery after ordering). 3. Providing easy accessibility to consumers. 4. Providing product assortment from different manufacturers.

The information services include helping consumers in:

1. Product search. 2. Merchant search. 3. Price search.

Besides these services, intermediaries also facilitate negotiation between buyers and sellers; and, help in building trust in the market mechanism. However, with rapid diffusion of the Internet, information flow can be de-linked with the logistics flow since an alternate channel that is more efficient is now available. The exponential growth of the 35

Internet will lead to a much more rapid growth of intermediaries that provide information services, in comparison to the logistics intermediaries. And to support commerce in the new channel so created, new types of intermediaries will also emerge that will fill the functional gap of trust and service support. 36

4 Restructuring of intermediary functions:

This chapter explores in greater detail the form and structure of the three types of intermediaries introduced in the previous chapter. Section 4.1 describes the reason for rapid growth of information intermediaries and the different types of information

intcrmCdiaries that have already come into existence. Section 4.2 describes the different types of logistics intermediaries that allow sellers to sell directly to end consumers without traditional intermediaries. Section 4.3 describes the types of value-added intermediaries that are coming into existence to support e-commerce.

4.1 Information intermediaries

Based on model developed by Baligh and Richartz (1967), it can be argued that the number of information intermediaries on the Internet will grow much faster than traditional intermediaries or intermediaries providing logistics services. To illustrate this, let's take a fictitious example where number of sellers (M) = 100, number of buyers (N) = 1000 and the contact and communication cost (C) is $5. Let's assume that the minimum level of return on investment (ROI) acceptable to any new intermediary entering the market is 20% and fixed cost (F) associated with entry of information

intermediary is about 1/ 10th that of traditional intermediaries (in absolute terms, say $5000 and $50000 respectively).

In equilibrium, the number of intermediaries (say Z) in the system will be determined as follows: According to Balderston (1958) model, new intermediaries will continue to enter the system till such point that the transaction cost in direct channel (M*N*C) becomes equal to the cost in the indirect channel ((M+N)*C*Z). However, according to Baligh & Richartz (1967), the entry of new intermediaries will stop much earlier due to the entry barriers associated with the fixed cost (investment) needed for entry. The profit potential is based on the difference in transaction cost between the direct and indirect channel. If 37 this profit potential falls below the expected minimum return on investment, new entrants will be discouraged from entering the channel. Hence, in equilibrium, F*ROI*Z will be equal to (M*N*C - (M+N)*C*Z). Therefore,

Number of intermediaries in equilibrium = M*N*C/(F*ROI + (M+N)*C) = 100*1000*5/(50000*0.2 + 1100*5) =32 After the advent of the Internet, the number of intermediaries in equilibrium will be: = 100*1000*5/(5000*0.2 + 1100*5) = 77 Hence, the number of intermediaries more than doubles! The above example is highly simplified but illustrates how the Internet can potentially impact the number of intermediaries in a channel, though it is relevant only to the information function of the channel. Hence the number of information intermediaries is likely to increase dramatically in comparison to traditional intermediaries. As some part of the value added by traditional intermediaries is taken away by these new information intermediaries, the number of traditional intermediaries may actually come down over a period of time.

Sarkar, Butler & Steinfield (1998) argue that the ability of electronic networks to reduce transaction costs will not result in bypassing of intermediaries in the electronic markets. On the contrary, it will reinforce the position of traditional intermediaries and also promote the growth of a new generation of intermediaries called "cybermediaries".

Based on this argument, they identify several types of cybermediaries that have already come into existence:

1. Directories: these services help consumers find sellers by providing structured menus to facilitate navigation and search. Examples are general directories like www.yahoo.com and commercial directories like 'The Embroidery Directory' by www.ud.net. 38

2. Search services: allow users to conduct keyword searches of web sites. Examples are www.lycos.com and http://infoseek.go.com/ (which have now actually grown out of the search engines category and become more of Internet portals/ gateways). 3. Malls: allow consumers to visit commercial sites that are listed in this 'mall'. These malls can have a geographic focus, like 'The Alaskan Mall' at http://alaskan.com/ or an aggregation of variety of products/ sellers like 'Cybersuperstores' at www.cybersuperstores.com. 4. Virtual resellers: are e-retailers that carry inventory in a few central locations and sell their products to the consumers on the Net. Examples are www.amazon.com that sells books, music, video etc., www.hugestore.com that sell men's apparel and 'International Shopping Club' at www.intsc.com that sells consumer electronics. 5. Web site evaluators/ Auditors: help consumers to reduce some risk by providing some form of evaluation of web sites. Examples include GNN. Firms like Nielsen (www.nielsen-netratings.com ) on the other hand help sellers evaluate the efficacy of different sites for advertising effectiveness by providing audience measurement services. 6. Financial intermediaries: are intermediaries that facilitate payment transaction between buyer and seller. Examples include credit card companies like MasterCard (www.mastercard.com/shoponline) and others like www.checkfree.com that provide electronic equivalents of writing checks. 7. Spot market makers: allow buyers and sellers to transact in ad-hoc spot markets. Examples of such services are www.ebay.corn and BarterNet at http://www.telepot.con-dtpdx/bnhome.htm. 8. Intelligent agents: are software programs that allow users to specify the search criteria to find products/ merchants that satisfy the criteria. Examples are BargainFinder (started by Anderson Consulting, but now discontinued) and www.firefly.com.

Hagel and Rayport (1997) argue that new technologies such as smart cards, World Wide Web browsers and personal financial management software will allow consumers to take ownership of information about themselves and demand value in exchange for it. 39

However, consumers will probably not bargain with sellers directly, but through companies called "infomediaries". These infomediaries will act as custodians, agents and brokers of customer information, marketing it to businesses on behalf of the consumers, while protecting their privacy at the same time.

They argue further that the best candidates to play this role are companies that have ongoing relationships with customers in a variety of commercial activities and have earned their customers' trust. In this respect, banks for example will be better positioned to become infomediaries than say retailers, who in turn will be better positioned than individual manufacturers. Over time, this industry may become concentrated because of economies of scope and increasing returns. Infomediaries with large and diverse customer base will enjoy economies of scope over those with narrower customer base. In addition, trust will provide increasing returns to the infomediaries and will raise the barriers to entry for newcomers.

4.2 Logistics intermediaries

According to consulting company Deloitte & Touche (Wilder, 1997), there is a big potential that distributors who do not add value can get replaced by freight companies. Companies like FedEx and UPS, who have an established logistics network, are well positioned to take this place in e-commerce. NEC for example (Fortune, 1994), has an agreement with FedEx to manage its entire distribution network, enabling it to reduce distribution cost from 2.6% of sales to 1.9%. It is not surprising therefore, that FedEx and UPS have vowed (Computerworld, 1996) that everything a customer does today will soon be done online- and their financial future depends on it. Both offer web-based package tracking solutions with 10,000 to 13,000 users using the site for tracking everyday.

Logistics services can also be provided by companies, who have developed an expertise in direct order fulfillment, like Fingerhut (www.fingerhut.com). Fingerhut Business 40

Services (FBS) offers order fulfillment services to companies that do not own the infrastructure to sell their products through catalog or online. For instance, Fingerhut has a relationship with Levi's (www.levi.com) that works as follows: the customer places an order for a pair of jeans on Levi's web site. The order is not handled by Levi's but by FBS. FBS receives the order, packs the merchandise that is warehoused at one of FBS distribution centers, and mails it to the customer. All service and product returns issues are handled by FBS on behalf of Levi's. Similar services are provided by Hanover Direct (www.hanoverdirect.com) through their Keystone Fulfillment Division.

4.3 Value-added intermediaries

By 2002, Gartner Group (www.gartner-group.com) predicts that 60% of wholesale distributors will earn most of their profits from post-sale services such as installation, warranty and training. Many value-added intermediaries have already come into existence to support the trust and service requirements of consumers in e-commerce. For instance, virtually all Dell warranty services are provided by third party vendors like Unisys Corp. and Wang Global through their PowerEdge services (www.dell.com/products/poweredge/service).

Similarly, for providing trust services, independent rating companies are coming up fast in the e-commerce arena. www.bizrate.com continuously surveys thousands of actual customers, as they buy online, compiling their shopping experiences into reliable merchant ratings consumers can trust to shop online. A rating for computer seller Cyberian Outpost (www.outpost.com) for instance, looks like below: 41

out of five stars I ...... Overall- Rating ...... Ease of Ordering 4*1|t On-Time Delivery ***1 Product Selection 4|r* Product Representation 1*** Product Information 4*ig** Customer Support * *** Price 4*lir Privacy Policies 1** * Website *4l& *4 Shipping & Handling ** |1 Customers Surveyet 5546 TIs PerIod: 2379 Report Ped:d 1/5 /99 - 4 /5 /99

ClearCommerce (www.clearcommerce.com), a member of the SET committee established by MasterCard and Visa, provides an array of services, including credit card authorizations, online order and payment processing, and fraud detection. During processing, a buyer's credit card information is transformed into an unreadable format after performing multiple checks for fraud. The fraud module verifies name and address, defends against credit card number-generating programs, and locks out suspect card numbers and IP addresses. Similarly, Verisign (www.verisign.com) is one of the leading providers of Internet trust services. 42

5 Developing an integrated framework:

In this chapter, various theories of distribution channels, reviewed in chapter 2 are integrated into a common framework with the objective of analyzing the sectoral impact of the Internet on intermediaries. Section 5.1 outlines the key factors that affect distribution channel structure and explains why certain parameters (like price) have not been included in this thesis for analyzing the impact of the Internet. Section 5.2 describes the impact of the Internet on these variables and relates it to the hypothesis outlined in chapter 3, that three distinct types of intermediaries (information, logistics and value- added intermediaries) can come together to provide an alternative to the traditional distribution channels. Section 5.3 describes how consumer buying behavior can modify the simplistic assumptions of section 5.1 and 5.2 and how it can be used to develop a decision flowchart that can be used to understand the sectoral differences in disintermediation. Section 5.4 describes the flowchart and possible disintermediation scenarios that may emerge.

The framework uses the following inputs to explore the changes in channel structure: " Consumer needs/ preferences. " Product characteristics. " Environmental factors.

Integrated Framework 43

The following steps were followed in creating a framework that can be used to differentiate the impact of the Internet on distribution channel structure for different industries: 1. Identify key variables affecting channel structure. 2. Exclude variables outside the scope of this research. 3. Identify the impact of the Internet on the selected variables. 4. Create a logical decision flow to understand difference among industries. 5. Evaluate different disintermediation scenarios based on the decision flow chart.

5.1 Key factors affecting distribution channel structure

From a review of the literature, following factors emerge as critical from the point of view of determining the normative channel structure:

Key variable Reference Relevance to channel structure Lot size Bucklin (1966) Smaller the lot size required by the consumer, greater the need for logistics intermediaries. Waiting time Bucklin (1966) Lesser the consumers' willingness to wait, greater the need for logistics intermediaries. Assortment Alderson (1957)/ More the assortment need of consumers, more the Bucklin (1966) need for aggregation intermediaries. Inconvenience Huff (1981)/ Higher the inconvenience cost of retail purchase cost Balasubramanian for consumers, higher the intensity of retail (1998) distribution required; and higher the threat from a direct marketer. Risk of purchase Sarkar et al Higher the risk of purchase error in direct error (1998) purchases without physical inspection, higher the need for intermediaries. Search/ Balderston Greater the search cost for consumers, greater the transaction cost (1958)/ need for information intermediaries. Williamson (1979) Service support Sarkar et al Greater the service support required by (1998) consumers, greater the need for value-added intermediaries who can provide after sales service. Customization Bucklin (1966) Higher the customization required by consumers, higher the viability of shorter channel. 44

The impact of these key variables on the channel structure can be summarized in the following influence diagram:

risk service support inconvenience search cost customization cost

need satisfaction transaction costs waiting time

assortment logistics customer channel flows satisfaction lot size -- requirements

What this diagram implies is that the flow of goods and services through a channel finally depends on how much the channel is able to satisfy the consumer needs and wants. These consumer needs can broadly be categorized into three types: product needs, logistics requirements and need to reduce transaction costs. Logistics requirements basically have three components: lot size, assortment required and time consumers are willing to wait. Transaction costs relevant to this analysis are: inconvenience cost, risk associated with buying a product without physical inspection and search costs.

Product needs are basically definable in terms of product features, price, quality, customization requirement and service support. Product features and quality can generally be considered as independent of the channel structure, and hence have been excluded from further analysis. Price is also excluded because in the short run, it is generally a strategic variable for a company while in the long run, it is dependent on the efficiency of the channel. For the purpose of this thesis, it is assumed that there is no significant price differential between different channels in a specific consumer segment; and if there is a price differential, it may be in either direction (i.e. direct channel price may be higher or lower than indirect channel). The basic point here is that the direction of price differential cannot be established without empirical research in a specific industry, and hence is beyond the scope of this thesis. 45

Generally it is believed that the information efficiency of the Internet will bring prices down because it will be easier to do comparison shopping online than through any other venue (Goldman Sachs, 1997). Also, with the ubiquity of the Internet, retailers will now have to compete on price with e-retailers and therefore the prices in general may go down at least in the short run. Many online sellers are already passing on the savings in web- commerce to the consumers. For example, 1-800-Batteries (www.800Batteries.com ) offers a discount to customers for online sales because the cost of sales over the Net is about half the cost for phone orders.

However, some studies done so far have not found any evidence of lower prices on the Internet compared to traditional retail channel. One exploratory study done by Bailey and Brynjolfsson (1997) did not find any evidence on the basis of data from 52 Internet & conventional retailers for 337 distinct titles of books, music CDs and software.

It is actually very likely that Internet will enable new types of price discovery mechanisms to be employed in different markets (Bakos, 1998). Traditionally, three types of price discovery mechanisms have been used:

1. Auctions (sellers or buyers bid in specified formats). 2. Negotiations (sellers & buyers negotiate directly or through intermediary). 3. Firm offers (customers can take it or leave it, as in most retail markets).

In electronic marketplaces, intermediaries such as www.priceline.com can allow buyers to specify product and price requirements and make corresponding offers to participating sellers, reversing the traditional function of retail markets. Priceline is a buying service that lets buyers request an offer at their price. Priceline then goes about finding a seller who decides whether or not to fill the request. With Priceline, there is no auction, no bidding and no back and forth.

Software agents such as Kasbah and Tete-a-Tete that can negotiate purchases on behalf of buyers and sellers are also likely to restructure the price discovery process. The ability 46 to customize product offerings and the new emerging price discovery mechanisms may allow sellers to also price discriminate- that is to charge different prices for different buyers. It can be a powerful tool that allows sellers to increase profits or survive the price erosion that may take place in friction-less electronic markets. It will also allow sellers to service buyers who would otherwise be priced out of the market, thereby increasing the overall economic efficiency.

As menu costs (cost of administering multiple prices) decrease due to the Internet's transactional efficiency, sellers will move away from fixed pricing to flexible pricing. This is already evident in the airline industry in U.S., which has increased profitability by revenue management (another term for flexible pricing). Flexible pricing will also counter price competition on the Net because consumers will find it difficult to compare prices.

Goldman Sachs (1997) has developed an Internet Retail Index to assess the Internet's ability to offer superior value to the consumers and the manufacturers, as defined by ten criteria. The criteria used for developing the index and the associated hypotheses are:

1. Information-intensive products can be marketed more effectively on the Net. 2. PC-users make natural target consumers for online sales. 3. Products with low distribution cost as a percentage of gross profit are better suited for Internet sales. 4. Products for which selection and prices change frequently are marketed more effectively on the Net. 5. Selection-intensive, slow turning items are idealfor Internet selling. 6. Products for which delayed gratification is acceptable are suitablefor online sales. 7. Products for which 'touch and feel' is not essential are more easily sold over the Net. 8. The Internet provides access to higher-income customers. 9. The more appealing conventional retailing options are the less likely the online sales. 47

10. Convenience is the key in online sales.

According to their analysis, products that are best suited for the Net based on above criteria are: 1. Computer hardware 2. Computer software 3. Books 4. Music 5. Electronics 6. Office products 7. New vehicles

Products that are not so well suited for Internet sales are: 1. Home furnishings 2. Auto parts 3. Off-price apparel 4. Perishable food

It may be noted that unlike the research done by Goldman Sachs where they have focussed on finding the suitability of online sales for different product categories, the focus of this thesis is to find the impact of Internet on channel structure in terms of disintermediation. While there may be some correlation between these two questions, the first does not imply the second. That is, if a product is suitable for online sales, it does not necessarily imply disintermediation.

Demographic variables, such as income, PC owner etc. are relevant for analyzing the transient stages of the evolution of a normative channel. Since this thesis is primarily concerned with the understanding of the normative channel in the context of e-commerce, such demographic variables have largely been ignored in this research. Other parameters used in this study are broadly covered in the key variables identified in the previous section. 48

5.2 Impact of the Internet & 3PL services:

To understand the possible changes in channel structures for various industries, it is now important to understand the impact of the Internet on the key variables identified in Section 5.1. Besides the Internet, however, there is another factor that has impacted the viability of direct channels: the growth of logistics services that have enabled the delivery of small packages over long distances to individual consumers at a reasonable cost. The following table summarizes the impact of the Internet and the availability of small parcel logistics services on these key variables:

Key variable Impact of the Internet Impact of logistics Viability of services direct channel Assortment Physical aggregation Physical aggregation Increases. capabilities not changed. Order possible by using aggregation possible on 3PL. Internet. Inconvenience Internet has provided a more No correlation. Increases cost convenient method of shopping. significantly. Risk No correlation. No correlation. Search cost Dramatically reduced by No correlation. Increases Internet. significantly. Service Self-service support possible No correlation. support through Internet. No correlationto physical service support. Customization Internet allows the possibility of No correlation. Increases. one-to-one marketing and customization. Lot size No correlation. Smaller lot size Increases. delivery over long distances has been made viable by 3PLs. Waiting time No correlation. Faster delivery over Increases. long distances has been made viable by 3PLs. 49

The above table shows that the combined effect of Internet and logistics services is to potentially provide a viable direct marketing channel, except for two issues that are not addressed by these factors:

e Risk of buying a lemon (Ackerlof, 1970). " Service support required by consumers.

Since the direct marketing channel has potential of enormous savings by reducing the number of players in a vertical market, it is very likely that new forms of intermediaries will develop who support this channel by independently providing services that address the two issues identified above. These intermediaries may be called "value-added intermediaries". Hence, an alternate channel to traditional wholesale/ retail channel would be combination of three types of intermediaries performing distinct functions but coordinating the overall activities with a view to satisfying consumer needs. The traditional role of intermediaries may therefore spilt into three as shown below:

Dell's case

Information Dell.com f intermediaries

Traditional Logistics FedEx Intermediaries Intermediaries

Value-added Unisys Corp. Intermediaries Wang Global

For example, in Dell's case, the information and transaction interface with customers is managed by the company itself through its web site; logistics is handled by FedEx; and, service support is provided by Unisys Corp. and Wang Global. It may be possible for one intermediary to provide more than one function. However, as described in an earlier 50

section, the number of information intermediaries will probably grow much faster than the other two because of the exponential growth of Internet and the low entry barriers associated with low capital costs of setting up a web site.

5.3 Consumer buying behavior

Although the previous sections identify the key variables that influence the consumers' preference of one marketing channel over another and the impact of the Internet on these variables, it needs to be recognized that consumers do not behave homogeneously even if the basic needs/requirements are the same. Hence it is important to understand the relationship between consumer buying behavior and the variables that determine channel structure.

There are several descriptive theories and models that attempt to capture consumer buying behavior-e.g. the Nicosia (1966) model, the Howard-Sheth (1969) model, the Engel-Blackwell (1982) model and the Bettman (1979) information processing model. Although different in their approaches, these models share a similar list of six fundamental stages guiding consumer behavior:

1. Needs identification: consumers become aware of some unmet need. 2. Product brokering: evaluation of product alternatives. 3. Merchant brokering: evaluation of merchant alternatives. 4. Negotiation. 5. Purchase & delivery. 6. Product service & post-purchase evaluation.

The following table maps the key variables identified in the previous section in terms of their importance to these stages of consumer buying behavior (CBB). It suggests that assortment, customization and search cost are the only variables that are important in the initial stages of CBB, while the other variables are important only for the later stages. 51

Need Product Merchant Negotiation Purchase Service & identification brokering brokering & delivery evaluation Lot size / Wait time V Assortment // Inconvenience / cost

Risk V _ Search cost Service // / Customization Price

Hence, assortment, customization and search cost could be thought of as primary filters that eliminate many channel possibilities in the initial stage itself, or at least significantly alter the balance in favor of one channel type over the other. For example, if the consumer needs an assortment of goods produced by different manufacturers (say basket of grocery items), it is very unlikely that s/he will purchase directly from the manufacturer, since the consumer knows instinctively that the cost of doing that will be very high.

Similarly, if the consumer requires customization of the product to suit his/ her needs, and the original manufacturer can do the customization more efficiently, a direct channel will be more likely. For example, while Amazon.com and other cybermediaries have been very successful in selling standard books over the Net, when it comes to customization, publishers are more likely to provide that service (since they control the printing process). McGraw Hill's college division pioneered the concept of customized textbooks: its Primis service (www.mhhe.com/primis) allows customers to select modules from different sources to create a customized textbook suited to the pedagogical style or objectives of an instructor.

If the consumer requires a lot of information in order to decide what to buy, or from whom to buy (may be because of the technical complexity of the product), s/he will 52 probably depend on an information intermediary to help with information collection or decision making.

In the Merchant brokering stage, all nine variables become important, but the consumer implicitly determines the expected inconvenience cost and risk involved in different channel options and reduces the consideration set based on these. For example, a consumer planning to buy apparel may decide against catalog/ Internet purchase because s/he doesn't want to take the risk of buying without touching or feeling the texture of the fabric. S/he may actually move back and forth between this stage and the next stage (Negotiation) in an iterative process before selecting a merchant, but negotiation generally involves only the following variables: lot size, delivery time, service, customization and price. Inconvenience cost and risk can therefore be considered as secondary filters that further narrow down the channel choices for the consumer.

Channel Choices

. . .Assortment, Need identificationAsote, Neeductidkentain Customization, Primary filter Product brokering Search cost

brokering Inconvenience Secondary filter Merchant cost, Risk

Lot size, wait time, service, Negotiation etc. price

The concepts described above are used later in the next section to develop a decision flowchart to understand the various (dis)intermediation possibilities for specific industries.

Variance in consumers' purchase motives is another important issue in relating the consumer buying behavior to channel preference. It will be too simplistic to say, for example, that a consumer would buy directly from a manufacturer (instead of an 53 intermediary) because his/ her requirements as defined by the key variables identified above are satisfied better by direct channel. It is quite impossible to straitjacket consumer buying behavior in such a manner. Extensive research, in fact, has been done in retailing to understand consumers' purchase motives. Samli (1998), for example, classifies consumers' purchase motives (in retail shopping) into nine categories:

1. Diversion 2. Self-gratification. 3. Learning about new trends. 4. Physical activity. 5. Sensory stimulation. 6. Social experiences. 7. Pleasure of bargaining. 8. Clearly identified needs and wants. 9. Specified pressures to shop.

From the above list, it is clear that Internet shopping can satisfy only some of these purchase motivations. However, technology is fast bridging the gap by creating intelligent software agents that can satisfy to some extent, even the pleasure of bargaining. Most software agents developed so far help a consumer in the search process, whether it is related to product, merchant or price. Some of the more developed versions however, can negotiate on behalf of the consumer. Guttman, Moukas & Maes (1998) compare some of the software agents in the context of the consumer buying behavior (CBB) model described above:

CBB stage PersonaLogic Firefly Jango Kasbah Tete-a-tete Product brokering Merchant brokering Negotiation

Firefly uses an automated collaborative filtering process that can be used to match users with similar profiles and make recommendations based on their shared interests. Tete-a- tete uses a combination of multi-attribute utility theory and distributed constraint 54 satisfaction problem protocols (CSP) to negotiate. CSP techniques are used to encode hard constraints like: I'm not willing to spend more than $2000" and soft constraints like "availability is more important than price".

Most Internet commerce sites now incorporate some kind of software agents and interactive tools that attempt to bring the retail shopping experience to the consumers' desktops. A case in point is NetMarket.com, a site run by membership discounter CUC (now Cedant Corporation). It has an innovative haggle zone (www.netmarket.com/SHP/scripts/HaggleZone.asp) that perhaps gives to the consumers the pleasure of bargaining more than real bargains. Another interesting example is www.sunglasshut.com, who is planning an interactive feature on their web site that will allow users to download a digital image of themselves to the site for virtual sun glass try- ons. In the final analysis, however, some of the retail shopping experiences may never be possible to simulate on the Internet. To that extent, the relationship between the key variables being studied and the expected channel structure, as developed in the next section, will be weakened and will need to be established for specific customer segments by empirical research.

5.4 Decision Flowchart

The relationship between the key variables and the channel structure based on the consumer buying behavior can be qualitatively represented by the flowchart shown on the next page. The following hypotheses are built into the flowchart:

1. Consumers are likely to prefer a direct channel if they do not require an assortment of products manufactured by different producers. 2. Consumers are likely to prefer a direct channel if they want customized products that manufacturers are in a better position to provide. 3. For information-intensive products, consumers are likely to depend on information intermediariesto help them in their search and selection process. 55

4. Consumers are likely to prefer retail channel if it is not very inconvenient to purchase from retail outlets and if the risk of purchase error cannot be mitigated without physical inspection. 5. If the product is amenable to logistics services provided by independent third party logistics service providers (defined as UPSable in this thesis), the purchase transactions may occur independent of logistics, increasing the viability of cybermediaries. 6. For products suitable for cyber sales, independent value-added intermediariesmay fill the functional gap of service and risk-mitigation. 56 0

y

y

00 0 0 57

Based on the logic of the flowchart as applied to various industries, as many as five different intermediary structures can be expected to evolve, depending on how the transaction and logistics functions are divided between different players in the channel:

Logistics function by:

Retailer Wholesaler Mfr.

Retailer .EZC

C Cybermediary

Cu Cu Manufacturer

For example, in scenario J), retailers perform both functions while wholesaler facilitates the logistics function, which has traditionally been the case. In this scenario, the Internet may help the consumers only in searching for products, merchants and prices. In terms of degree of disintermediation, scenario 1 to 5 represent increasing disintermediation as shown below:

High

Disintermediation

Of Logistics function

Low High Disintermediation of Transaction function 58

While the economics of logistics function has not changed drastically in the last 4-5 years, the economics of who can manage the transaction function (i.e. customer interface) has changed considerably due to the explosive growth of the Internet. Since everyone wants to be closest to the customer in order to capture maximum value in the demand chain, there is a race among the various players to occupy the consumers' top-of-mind cyberspace. On the other hand, conflict with their existing business pushes these players in the opposite direction. Hence, scenario @ and @ can be considered to be fundamentally unstable and moving towards their natural equilibrium over a longer period of time, based on who can provide more efficient logistics.

In the long run, Scenario @ is likely to merge with scenario 4 with the retailer being disintermediated by the cybermediary, or scenario T with retailer occupying the cybermediary space. Similarly, scenario @ is likely to merge with scenario @ with manufacturer disintermediating the wholesaler and retailer after overcoming channel conflict. In this long-run equilibrium, the channel structure will be determined primarily by logistics and marketing considerations and the customer interface will be managed by the last entity in the channel.

From the above discussion, it is clear that 'disintermediation' is not a 'yes' or 'no' question. There are various shades of disintermediation possible. Next section analyzes these scenarios in greater detail in reference to different industries and the major players in these industries. 59

6 Exploratory Analysis:

This chapter explores in greater detail, the disintermediation scenarios introduced in the previous chapter, specifically in terms of their applicability to various industries. The analysis is exploratory in nature and needs to be supported by empirical research and detailed case studies. However, the current state of Internet commerce is in a highly fluid stage rendering empirical research difficult and deriving conclusion from such research even more difficult. Section 6.1 describes the five disintermediation scenarios in terms of the market characteristics and consumer buying behavior explained via the decision flowchart as it applies to different industries. Section 6.2 provides a more in-depth view for two industries in the form of case studies and section 6.3 briefly outlines some of the limitations of such exploratory analysis.

6.1 (Dis)intermediation scenarios:

Scenario ( In this scenario, consumers only research the information required (on products, merchants, prices etc.) on the Internet and finally buy from traditional retail channel. This is likely to happen for products where: " Assortment is required by customers, and/or e Customization is not required, or if required, cannot be economically provided by the manufacturer. In this case, customization may be provided either by the retailer or by independent value-added intermediaries. An example would be customized jewelry, furniture or bicycle. " Risk of purchase error is high and cannot be mitigated without seeing the product, as may be the case for apparel.

The decision flowchart for purchases in this category will be a subset of the generic flowchart described in the previous section, and would look as follows: 60

y

For information-intensive products, even though consumers may buy from retail, they may use the Internet to search for the right product or merchant using information- intermediaries or "infomediaries". Examples include general search engines like www.yahoo.com, intelligent software agents like www.firefly.com and industry specific intermediaries like www.autobytel.com for auto industry and www.pricewatch.com for computer industry. The distribution channel for such goods will look like the following:

Manufacturers 0,Wholesalers Retailers Consumers

Infomediaries

Home furnishings (e.g. furniture) and apparel are likely to fall in this category. It may be noted that the risk of purchase error is a very real and important issue for consumers in direct purchase. This is reflected in the high percentage (25-40%) of returns (Goldman Sachs, 1997) for apparel mail order catalog companies. A report published by market 61 research firm Cyber Dialogue (www.sonnetech.com/corporate babble/pr27.html) indicates that 60% of Internet shoppers do not trust the color they see on their monitors. The study further reports that about 30% of online shoppers decided not to purchase a product because the true color of the product was in doubt and almost 15% of shoppers returned items because the online color did not match the actual product that was delivered. There will, of course, be some consumers (albeit not a large proportion) for whom risk of purchase error is not important or, they have already experienced a specific brand and therefore the risk of buying the same brand again without seeing is not very high. Such consumers may prefer to buy from a cybermediary, as discussed in scenario 2.

Apparel became AOL's e-commerce category leader in 1997, surprising nearly every industry analyst. However, e-commerce revenues accounted for only 3.8% of total retail sales in 1997, and few expect the Internet to savage the $169.2 billion retail apparel industry. Strongest online entrants are retailers from the catalog world (which is about $14 billion market). www.eddiebauer.com complements its retail and mail order business with its web site that has excellent options of product search, catalog request, virtual dressing room, store locator, wish list, reminder service & weekly specials. It's Virtual Dressing Room lets shoppers maneuver actual photos of clothing with click and drag-and-drop ease to virtually build and view coordinated fashions. www.landsend.com, the largest catalog company has an interactive shopping with real-time inventory access on its web site. Lands'End Inc. decided to close 3 out of its 19 stores because it found catalog and Internet to be much more cost effective that outlet stores in liquidating overstock and end-of-season inventory (Computerworld, 1999). www.fashionmall.com, the first online apparel store has a wide assortment of products and links to sellers. www.gap.com is one of the few non-catalog-based brands that made a quick transition to Net commerce. The Gap Online Store, which opened in 1997, creates an exciting and interactive shopping experience. Some of the big names in retail like Neiman Marcus, Nordstrom, Gucci & Hugo Boss have however not aggressively deployed an Internet strategy. It seems that 62 these companies believe that the social experience of shopping in stores for high-end apparel overrides Internet-based advantage.

Levi Strauss & Co. (www.levistrauss.com), the world's largest brand-name apparel manufacturer with 1998 sales of $6 billion, opened its Online Store in November 1998 and now offers a broad selection of Levi's apparel. VF Corporation (www.vfc.com), world's largest publicly held apparel company (owners of Lee & Wrangler brands), launched its e-commerce initiative in February 1999 by making its Healthtex brand available online for retailers. Finding a way to better support retailers was the primary impetus for developing the site. According to Mackey McDonald, chairman of VF Corporation, their primary effort is to develop a collaborative partnership with their retailers, complemented at some time in the future by a direct-to-consumer capability to ensure broad coverage of the combined consumer base (www.vfc.com/frame news.html).

With strong brand names in retail industry in the forefront of Internet commerce and manufacturers lagging behind, disintermediation seems to be an irrelevant possibility in apparel industry.

Home furnishings: The $31.8 billion home furniture segment so far comes in dead last in the race to hit the Internet. Most analysts say furniture is too heavy to ship and too expensive & sensory dependent to buy unseen (Forbes ASAP, 1998). Small appliances, home accessories, and soft textiles such as towels and sheets fit the Net better. www.eddiebauer.com has been selling on the Net since 1994 and now offers more than 1200 products online. However, the cost of delivery is as high as 20-25% of the price of the furniture and order fulfillment takes a considerably long time. For larger furniture items that are a manageable size, shape and weight, and are easy to assemble, there is a Basic Freight service to deliver the boxed furniture to the customer's door. Basic Freight ships in 2 to 4 weeks with additional 10 business days for transit. This implies that the customer has to wait for more than a month to get delivery. For all larger-sized or unwieldy pieces, there is a White Glove Delivery service that ships in 4 to 6 weeks with additional 3 weeks for transit. For furniture that can be delivered by UPS, it is usually 63 shipped in 1 to 2 weeks with additional 8 business days for transit. UPS rates for furniture are based on UPS charges for "oversized" packages. With such high cost and wait time for delivery, online market for furniture will probably remain a small niche.

Scenario @ In this scenario, consumers buy the goods on the Internet, but the goods are shipped from a retail outlet to the consumers or picked up from the retail outlet by the consumers. In this case the wholesalers & retailers perform the logistics function, while "cybermediaries" perform the transaction function. Additionally, the "last-mile" logistics function may be performed by the retailer or a local logistics service provider coordinated by the cybermediary. This is likely to happen for products where: * The consumer requires assortment of standard products (e.g. basket of grocery products purchase every week). * Retail is inconvenient and risk of purchase error is either low or can be mitigated by an intermediary. * Product is not UPSable. 64

The distribution channel for this category will look like the following:

Manufacturers Wholesalers Retailers Consumers

Cybermediaries

This channel structure appears to be suitable for products like groceries. It is very likely that retailers will occupy the cybermediary space in this channel. However, for now the major retail chains, which dominate the U.S. $426 billion grocery business, aren't willing to take too many risks on the Net, but are backing online-based newcomers to test the waters. That may be because food retailing is a low-profit (1.0% industry-wide), high- perishable business that's not especially well suited to e-commerce, despite its convenience factor. www.peapod.com for example, has partnered with Safeway, Kroger's and Stop & Shop. www.homeruns.corn is backed by $3 billion food retailer Hannaford. However, one of the biggest U.S. food chains, www.winndixie.com ($13 billion in 1997) is not selling online. The general format evolving is that online retailers (cybermediaries) either are tying up with retail chains or big retail chains are themselves getting into online business. The level of disintermediation in this category can therefore be expected to be insignificant. However, CUC International Inc. is trying a different approach through www.netgrocer.com, a part of a much broader strategy to sell almost everything a consumer may want on the Net (www.netmarket.com). This strategy disintermediates the retailer and is discussed in greater detail in scenario 4.

Scenario @ In this scenario, consumers buy the goods directly from the manufacturer at its web site but the goods are delivered to, or picked up by the consumer from the retail outlet. This is likely to happen under following conditions: 65 e No assortment is required " Product is information intensive. " Retail is inconvenient. * Risk of purchase error is either low or can be mitigated by an intermediary, and e Product is not UPSable.

The decision flowchart for this category will be as follows:

y 66

Actually, these conditions favor total disintermediation (as discussed in scenario 5), except that the logistics for these products is difficult or uneconomical if managed by the manufacturer without wholesalers and/or retailers. This scenario may therefore also represent a transient stage for a channel that may eventually evolve into a direct channel (implying complete disintermediation), but is currently unable to move towards its natural equilibrium because of channel conflict. In the computer industry, the channel conflict is already evident with companies like Compaq and HP trying all possible strategies to participate in the rapidly growing online market while making sure that their relationships with the existing channel are not jeopardized.

Many home appliance companies redirect consumers to e-retailers to avoid channel conflict or to experiment with online sales without directly getting involved. For example, LG Electronics (www.lgeus.com) redirects consumers who come to its web site to buy online, to Internet retailer Today's Merchandising, Inc. (www.shopping- today.com).

The channel for this category will look like the following:

Manufacturers loWholesalers Retailers Consumers 0-~ 1

Mfr.'s web site -0

Infomediaries -

Large consumer appliances and cars are likely to fall in this category. Auto retailing is a $500 billion business in the U.S. and accounts for up to one third of the final price to the consumer (Fortune, 1996). For logistical and legal reasons, consumers may always have to depend on a franchised dealer, but Internet greatly facilitates the most difficult part of the purchase process: information search and comparison-shopping. Selz and Klein (1997) have identified the emergence of two types of cybermediaries: automotive service brokers and automotive information brokers. www.autovantage.com is a broker service 67 that brings together potential buyers and sellers. Autovantage forwards a potential customer's inquiry to a dealer close to the customer, who then offers a price within two working days. Similar service is provided by www.autoweb.com, www.autobytel.com and www.dealernet.com. However, these cybermediaries basically link the customer to the nearest dealer after s/he has decided on the model to buy. Manufacturers have also now entered the fray, and can potentially provide more value addition than independent cybermediaries with real-time inventory information and customization possibilities. For example, at http://www.gmbuypower.com/, a GM customer can, after identifying the model s/he is planning to buy, choose an actual vehicle right down to the Vehicle Identification Number (VIN). A potential customer of Ford (www.ford.com) can custom- configure a car on its web site in terms of the powertrain, exteriors, interiors, audio, wheels/ tires etc. and then request for a dealer quote for the customized car. Hence, in the long run, it is likely that consumers will use information intermediaries to do preliminary search, then buy the selected/ customized car directly from the manufacturer and take delivery from the nearest dealer.

Scenario @i

In this scenario, consumers buy the goods on the Internet, and the goods are shipped from a central warehouse (or a few warehouses) directly to the consumers. This is likely to happen for products where:

" The consumer requires assortment. * Product is information intensive (search effort and cost is high). " Retail is inconvenient and risk of purchase error is either low or can be mitigated by an intermediary. " Product is UPSable.

The decision flowchart for purchases in this category will be as follows: 68

y

In this case the retailers are disintermediated, while "cybermediaries" perform the role of electronic retailing and physical wholesaling. This would be possible only with the logistics support from parcel companies like FedEx or UPS. Examples include www.amazon.com and www.buy.com who are linked to the wholesalers for physical logistics or own the wholesaling function also. The channel for this category will be as follows: 69

This scenario appears likely for products like books, toys, wine, music CDs and video. Catalog marketers who have turned to e-retailing are essentially using this model to reach directly to the consumers. Cedant Corporation (earlier CUC International, Inc.) for instance, started an electronic superstore (www.netmarket.com) that sells more than 250,000 brand-name products at a hefty discount of 10% to 50% off the manufacturer's price list (BusinessWeek, 1997). To get those discounts, CUC has set up NetMarket like its regular shopping clubs where the discounted rates are made possible by membership fees.

Traditional music CD & video outlets could be in greatest danger from online shopping sites. "This is one industry that will be rocked by e-commerce," predicts Piper Jaffray's Bill Burnham (www.piperjaffray.com). While online music revenues accounted for just $71 million of the $12 billion U.S. market in 1996, analysts predict that online revenues will easily double in 1999.

One thing that is common among all the online sellers is that they offer a huge variety of titles that is impossible to match for a traditional retailer. www.towerrecords.com sells more than 200,000 music titles, commanding 14% of online sales in this category. www.columbiahouse.com is the second most popular site on web. www.cdnow.com, the first online-only CD seller, recently teamed up with MusicBoulevard (www.musicblvd.com) to offer an impressive array of more than 250,000 titles. www.reel.com offers more than 35,000 video titles for rent and 85,000 titles for sale. On the other hand, the big retailers have been slow in embracing the Net. www.virginusa.com has about 60 megastores worldwide, but is not selling online and www.blockbuster.com started selling online only in 1998.

Toys (total U.S. market is about $22 billion) are terrifically suited for online sale: usually small, easy to ship, kids don't need to try them and convenient for parents. Several companies have launched toy business on the Web in the past two years, from Internet- only resellers such as eToys Inc. (www.etoys.com) and WebMagic's www.toys.com to well-known retailers such as FAO Schwarz (www.faoschwarz.com). All offer hundreds 70 of products available for immediate delivery. Consumers also find shopping hints and buying guides designed to make it easier to find the right toy. FAO Schwarz carries over 250 products and plans to expand online selection to more than 1000 products. Holt Educational outlet has gone much further and provides a selection of over 20,000 items to search from. Its e-commerce site has proven so successful that the company has abandoned plans to open new brick-and-mortar storefronts, deciding instead to concentrate on its web site (Sales & Marketing Management, 1999). As usual, the big brands like Mattel and Hasbro have shied away from Internet commerce for fear of disrupting their distribution channel.

Wine & spirits: Although online potential of wines & spirits is high, currently it is limited by a regulatory environment that prohibits the transfer of wines and spirits across state lines. www.klwines.com was voted as one of the best online wine retailer by Money magazine. Virtual Vineyards (www.virtualvin.com), founded in 1994 is one of the most talked about wine e-retailer. It offers advice as well as wines on its site. Virtual Vineyards is one of the few online merchants to offer the digital cash payment service. Again as in other categories, the big retailers have been slow to react. www.ejgallo.com, the granddaddy of jug wine retail does not offer its wines online.

Scenario @ In this scenario, consumers buy the goods directly from the manufacturer at its web site and the manufacturer ships the goods directly to the consumer using third party logistics service providers. This implies complete disintermediation by the manufacturer (Most quoted example of this case being www.dell.com). This is likely to happen for products where:

" No assortment is required e Customization is required and can be economically and more efficiently provided by the manufacturer. " Product is information intensive " Retail is inconvenient 71

" Risk of purchase error is either low or can be mitigated by an intermediary, and * Product is UPSable.

The distribution channel for this category will look like this:

Manufacturers

Mfr.'s web site

Logistics Intermediaries

The decision flowchart for purchases in this category will be as follows: 72

Computers and consumer electronic products will fit into this category. The case for computers is discussed in detail in the next section.

Consumer electronics is a $166 billion market, and even though there is tremendous potential for direct sales to consumers, very few companies are addressing it online. One reason for this may be the absence of early adopters or innovators like Dell in this market. Consumer electronics was ninth in online sales in 1997 behind such retail segments as jewelry. However, Forrester Research (www.forrester.com) expects the market to triple in the next two years.

As may be expected, the first movers in this market are retailers from the catalog/ direct marketing world. www.igvc.com, the no.1 general merchant on television, has more than 100,000 products on its web site. www.crutchfield.com is another direct mailer leveraging its direct marketing experience on the Internet. www.netmarket.com provides an interactive & entertaining shopping for more than 10,000 electronic items from more than 300 manufacturers.

Consumer electronic manufacturers have, on the other hand, not been aggressive on the Net till recently. www.panasonic.com has put up an electronic catalog on the Net, but does not give the option of buying online. www.sony.com similarly has an extensive electronic catalog, but only computers, digital cameras and accessories are available for shopping online. The manufacturers are clearly going slow in order to avoid channel conflict. However, as noted earlier, the potential for disintermediation is quite high in consumer electronics, and therefore it may be a matter of time before the manufacturers start offering their complete range online. 73

A summary of differences in (dis)intermediation for different industries that may emerge in e-commerce is given below:

Parameter Books Music/ Toys Computers Consumer Video electronics Assortment y y y n n Customization n y/n n y n Info search y y y y y Risk n n n n n Service support n n n y y UPSable y y y y y Transaction by: C/M C/M C/M Mfr. Mfr. Logistics by: W/S W/S W/S L/IM L/IM Types of C/M C/M C/M I/M I/M intermediaries L/IM L/IM L/IM VA/IM VA/IM Likely scenario

Parameter Groceries Apparel Cars Furniture Wine Assortment y y/n n y/n y Customization n y/n y/n y/n n Info search y y y y y Risk y/n y y y n Service support n n y n n UPSable n y n n y Transaction by: R,C/M R,C/M Mfr. R,C/M C/M Logistics by: R R, L/IM R R W/S Types of C/M C/M I/M C/M C/M intermediaries R R, VA/IM R, VA/IM R, VA/IM L/IM Likely scenario (;i

R Retailer W/S Wholesaler Mfr. Manufacturer L/IM Logistics Intermediary I/M Information Intermediary C/M Cybermediary VA/IM Value-added Intermediary 74

Based on the above mapping for key variables, the likely scenarios for these nine industries will look like the following on a linear disintermediation scale:

z W io @W O0~ ~ o@*

Low disintermediation High disintermediation

And on a two-dimensional disintermediation grid (one axis representing transaction and the other logistics), the likely scenarios will look like the following: High

Low High Disintermediation of transaction function

Next section provides a more detailed analysis for following two industries: e Books (representing key requirement of assortment and search). * Computers (representing technical complexity and customization requirement). 75

6.2 Case studies:

6.2.1 Books:

At more than $20 billion (1996), the book industry is growing at a slow but steady pace, about 3% annually in recent years (Hoover's, 1999). Book superstores such as Barnes & Noble and Borders Group and newer virtual superstores such as Amazon.com have had a tremendous influence on the industry in recent years.

Amazon.com (www.amazon.com) is one of the pioneers of Internet commerce and perhaps the best known bookseller on the Internet. Jeff Bezos started Amazon.com when he saw that there was a broad field of book publishers but too many titles to be carried by a single store (Hoover's, 1999). Amazon's well-publicized success as an online intermediary is the result of a database of more than a million titles in its virtual inventory and its use of Internet technology for developing communities in a way that a traditional book retailer cannot replicate (A.T.Kearney, 1999). Amazon now offers an easily searchable trove of 3.1 million titles--15 times more than any bricks-and-mortar bookstore, without the related overhead. Its 1,600 employees generate, on average, revenues more than triple that of No. 1 bricks-and-mortar bookseller Barnes & Noble Inc.'s 27,000 employees (BusinessWeek, 1998):

Amazon Barnes & Noble No. of stores 1 web site 1000+ Titles per superstore 3 million 175,000 Book returns 2% 30% Sales per employee $375,000 $100,000 Inventory turns 24 3 76

Amazon's success with books is also due to the fact that books are quasi commodities (Willis, 1998) - there is no need to try them on before you buy- and that they are small- ticket, impulse items that are easy to ship.

Following the logic of the flowchart given in Section 5.4, it is clear that the books have high potential for online sales by cybermediaries and the retailers stand the greatest risk of disintermediation. The wholesaler is needed because the large number of publishers and consumers make physical aggregation almost impossible without a logistics intermediary. The following flowchart shows why disintermediation of the retailers is a strong possibility in this industry:

y

y

Disintermediation of retailers in the book industry is already evidenced in the closing down of small independent booksellers like Waking Owl Books in Salt Lake city, 77

Baxter's Books in Minneapolis and Printers Inc. in Palo Alto, California (WSJ Interactive, 1999). Hence, the distribution channel evolving in books is as follows:

Publishers joWholesalers Ret rs Consumers

'ACybermediaries

Logistics Intermediaries

Amazon.com started as a cybermediary without doing the physical aggregation function itself and instead depending on wholesalers like Ingram Book Group (www.ingram.com), which is the largest wholesale distributor in US, serving more than 32,000 retail outlets and representing more than 12,000 publishers. However, with the takeover of Ingram Book by Barnes & Noble, Amazon is now strengthening its distribution network by establishing its own distribution centers (The New York Times, 1999). Before the Ingram/ Barnes & Noble deal, Amazon's supply chain looked like the following:

Publishers Ingram/ pConsumers Amazon's DC

Amazon '

Barnes and Noble, under threat of disintermediation, did the obvious thing, of integrating backward (by buying Ingram) and opening its own web site. The acquisition has given Barnes & Noble tremendous leverage in distribution channel and capability to service online customers directly from key distribution centers. This shows how the Internet is reshaping the structure of the distribution channels and how the changes in efficiency of information aggregation and flow is resulting in the reorganization of the functions performed by the intermediaries. The distribution network for book industry in the US after the Ingram acquisition is shown below (Christian Science Monitor, 1999): 78

Book distribution centers Barnes & Noble's purchase of Ingram, the country's leading book wholescler, is reshaping the US publishirg industry. Seattle

m Roseburg, ardsbur. Ore. Chanbersburg, Beleville, Mich. M-- Pb. Ann Arbor, Mich,-O Reno, East Windsor, Fort Woyne, Ind.* .1Conn. ONev.' Denver indionopolis 0 tNew Castle, S Chino, Colif. Det 0 Ontario, Calif Nashville, Tenn.* (4!sites) F.- Petersburg, Va. La Vergne, Tenn. (2 sites) Newport, Tenn. a tngram o Borders SAnozon.om } *Return Conter Jc&ANM~wQvj Soiace j.FPMhixar

In fact, Barnes & Noble has gone even a step further. It purchased Lightning Print Inc, a print-on-demand publisher in Nashville and a subsidiary of Ingram Industries. Print-on- demand publishers store books electronically and can print single copies of hard-to-find books - or even individual chapters. Previously, publishers believed that unless a book could sell at least 1,000 copies, printing it wouldn't be profitable. Print-on-demand makes it profitable at 250.

So, effectively what Barnes & Noble is doing is integrating backwards to gain as much control on the distribution channel as it possibly can and therefore reduce the risk of disintermediation. B&N perhaps envisions a channel that looks like the following:

Publishers Ingram B&N Consumers

B&N.com 79

With such a grip on the distribution channel, it appears that Barnes & Noble is positioned well to compete in both 'bricks-and-mortar' and online markets. However, with so much investment in retail outlets, Barnes & Noble may never be able to achieve return on assets comparable to Internet-only sellers like Amazon.com.

Though the book industry may eventually evolve into a multiple channel structure (i.e. both retail and Internet exist), it is clear that the retail channel will suffer major setbacks because of the higher efficiency of the cyber channel.

6.2.2 Computers:

The computer industry is a $500 billion industry growing at more than 20% per year. The PC segment in this industry is about $67 billion and growing at 30% per year. Dell Computers (www.dell.com) has been extremely successful in selling computers on the Net and expects to get more than 50% of its revenues by year 2000 from online sales (Inter@ctive Week Online, 1998). Eventually, Dell is also expecting more than 50% of its sales to come from customers outside US. The key elements of Dell's strategy (San Jose Mercury News, 1998) are:

e Dell doesn't aim at first-time buyers. It targets selling directly to customers who are computer-savvy and know what they want. e For Dell, being direct isn't just a matter of taking orders on the phone or a Web site. It's an organic part of the operation. For example, Dell is planning to take the direct- contact notion considerably further by linking customers' online feedback about quality and reliability directly with its suppliers' computer systems.

As a result of this strategy, Dell has historically sold about two thirds of its machines to big business and government. It has set up more than 8000 "premier pages" on the Dell web site to customize the purchase process for its large customers. This translates into huge savings for its customers by reducing the transaction cost of purchase. Ford, for 80 example, saved about $2 million in the procurement process (Inter@ctive Week Online, 1998).

On the other hand, Gateway (www.gateway.com), a company that follows a business model similar to Dell, has historically concentrated on the home market (US News & World Report, 1998). However, the two companies are now trying to steal each other's market by expanding their target markets.

Companies like Dell and Gateway have been very successful in selling direct because of some peculiarities of the computer industry. The obsolescence rate in the industry is extremely high, with inventory depreciating at a harrowing rate of 1% to 2% per week (Money, 1999). As a result, the longer the channel, the higher is the inventory cost. Such inefficiencies overwhelmed Compaq (www.compaq.com) in early 1998, when its inventory backlog crept up to nearly 10 weeks. The company had to slash prices to reduce inventory down to three weeks, but is still nowhere near Dell's inventory of about one week.

The other important factor has been the ability of these companies to offer a customized product. Buyers can configure the computer system they want to buy on the web site. Both Dell and Gateway, for example, give a wide configuration choice in terms of hardware, software, memory, drives, financing and service & support options.

A review of the key parameters determining the channel structure for this industry reveals that there is a high likelihood of total disintermediation, of the type portrayed in scenario 5 in earlier section, happening over a period of time. All of the following factors favor a direct channel:

1. Customers generally require no assortment. 2. Product purchase is highly information intensive because of high degree of technological activity in this industry and the wide variety of product configurations possible while buying, 81

3. Retail is not so convenient and does not add much value to the consumers decision making process. 4. Risk of purchase error is low because of established brand equity of most players in the market. 5. Computers are high value items and UPSable. The cost of direct shipment to end customer is therefore not very significant compared to the cost of the product.

Based on the above analysis, the decision flow chart for computers looks as follows:

y

A study by IDC (www.idc.com) has forecasted that by year 2001, there will be a major shift to direct channel in the PC market. The study predicts an increase in direct sales from about 28% in 1997 to about 34% in 2001. The fact that computers are perhaps the 82 best-suited product category for direct sales over the Net is also evident from the fact that the revenue of 10 computer-only catalogers ($27 billion), including Dell and Gateway, accounted for more than 45% of total catalog sales ($60 billion) in US in 1997.

Since computer purchase is such an information-intensive exercise, the flowchart also suggests that there is a place in the market for information intermediaries. However, even if the information intermediaries sell on the Net (as cybermediaries), they would not be able to easily provide manufacturer's customized solutions to the buyers. This is seen on the web sites of e-retailers like www.compusa.com who provide in-store configurations of manufacturers like Compaq and HP, but custom-configured products only from its own brand of AmericanPro and AmeriNote.

However, the key question is whether consumers will use such e-retailers for only information search or also for buying on the Net. To explore this further, the prices of various products offered by CompUSA are compared with the direct offerings from the manufacturer (as on 4/3/99): Product CompUSA Manufacturer Comments Sony Vaio PCG- $1799.95, available $1799.99 505TS Notebook for backorder vaiodirect.sel.sony.co m/ Sony Vaio PCG- $2699.95, available $2699.99 838 PC Notebook for shipment Sony Vaio PCV- $2299.97, available $2799.99 Special price offer E518DS Desktop for shipment (Xtreme buy) Toshiba Satellite $2099.95, available $2499.00 ESUP, Toshiba sells 4025CDT for shipment Retail series online through Notebook www.csd.toshiba.co resellers only. m Toshiba Tecra $2554.95, available $2699.00 ESUP 780CDM Notebook for backorder HP Vectra VL, $1299.95, available $1363.00 Special price offer Minitower for shipment www.buy.hp.com by CompUSA HP Omnibook No common offerings.

From the above table, it is clear that the reseller (CompUSA) price is generally less or equal to the manufacturer's price. While Toshiba allows custom configuration of products 83 online, when it comes to buying online, the user is redirected to the resellers' web sites. HP on the other hand is generally selling products through its 'commerce center' that are not being offered through resellers. It is apparent that the manufacturers are torn between trying to participate in the growing Internet sales and avoiding channel conflict. With increasing downward pressure on prices in the computer industry, it may not be long before manufacturers start offering the full range of products at competitive prices on their web sites, competing directly with their own channel partners. The channel is currently evolving as follows:

Manufacturers Distributors Resellers Consumers

Cybermediaries

The channel conflict arising in the industry is primarily due to the reason that everyone: manufacturers, distributors and resellers wants to occupy the space of cybermediaries. And in the long run, there may not be enough space for too many players in this area. For the time being however, every player in the channel is vying for the cyberspace; leveraging whatever possible relationships they can create or manage in the marketplace. For instance, Internet retailer www.buy.com purchases computers from distributor Ingram Micro Inc. thereby disintermediating the retailers but leveraging the distributor infrastructure (WSJ Interactive, 1999). Similarly, www.oisale.com has a supply agreement with Tech data Corp., a PC distributor with $12 billion in revenues.

However, the manufacturers are clearly in the best position to sell directly to buyers, and therefore it appears that the channel will gradually evolve into the following structure:

Manufacturers Consumers

Value-added -" Resellers

Infomediaries ' 84

The existing resellers who already have large investments in brick-and-mortar outlets will therefore migrate from being just resellers to being value-added resellers, also providing information services to buyers in the form of product/ merchant/ price search. For example, computer distributor MicroAge Inc. transformed itself from a supplier-focussed company to one whose sights are set on customer-centered value-added services (Software Magazine, 1997)

The value-added intermediaries may also be independent players that provide only service support and not participate in the sales transactions. For example, third party vendors like Unisys Corp. and Wang Global provide virtually all Dell warranty services through its PowerEdge services.

6.3 Limitations of exploratory analysis:

The analysis done in Section 6.1 and 6.2 is only exploratory in nature and needs to be supported by empirical research. It also does not take into account the variance in needs of different consumers that may be identifiable by market segmentation. For instance, the computer industry can be segmented into high-end and low-end segments that clearly have different needs and therefore may be served best by different channels. For high-end (generally custom configured) computers, a direct channel supported by build-to-order strategy may be desirable, while for low-end computers, an indirect channel may be more desirable. Even within the same segment, there would be variance in consumer needs and behavior. For instance, some consumers may find retail purchase inconvenient while others may actually find it enjoyable. Similarly, for some consumers, the risk of buying without physical inspection may be insignificant while for other consumers, it may be significant enough to dissuade them from buying on the Net. On account of the above reasons, the conclusions derived from the exploratory analysis are necessarily weak and need to be supported by adequate market research. The conclusions are also weakened by the fact that it is too early in the diffusion cycle of the Internet, and therefore current state of Internet commerce may not be representative of the long-run equilibrium. 85

7 Conclusion:

7.1 Thesis findings:

This thesis explores the impact of the Internet on the structure and form of intermediaries and analyzes the sectoral differences in disintermediation. Eight critical variables that affect the structure of distribution channels are identified and analyzed in the context of the Internet's capability to provide a low cost information and transaction medium for sellers and buyers. The relationship between these variables and channel structure is developed into a flowchart that is used to analyze five different disintermediation scenarios.

These five scenarios suggest that the notion of complete disintermediation, i.e. elimination of all types of middlemen from the distribution channel is farfetched and misplaced. However, this does not imply that the Internet will have no significant effect on intermediaries. On the contrary, Internet is likely to reshape the role played by intermediaries and therefore new forms of intermediaries and distribution channels will emerge. Traditional intermediaries will transform into or will be complemented by three distinct types of intermediaries: 1. Information intermediaries, who will primarily provide information and transaction services to the consumers. 2. Logistics intermediaries, who will provide logistics services between the sellers and buyers. 3. Value-added intermediaries, who will provide services related to trust and service support required for the cyber markets to work.

Although the transient stage in the evolution of this channel transformation will be determined by the channel conflict and the race to occupy the cyberspace, in the long run the channel structure may be expected to be determined primarily by logistics and 86

marketing considerations. Hence, in the long run, basically three different scenarios may emerge: 1. The retailer, who will have brick-and-mortar outlets as well as cyber-outlet, handles the transaction and last-leg logistics. 2. The wholesaler, who will have distribution centers as well as cyber-outlets, handles the transactions and last-leg logistics. 3. The manufacturer will directly handle the transactions and logistics (using 3PL services).

7.2 Future research:

This thesis provides a framework that can be used as a starting point for further research on understanding distribution channels and integrating the different approaches found in the literature. Research on marketing/ distribution channels requires an interdisciplinary approach that is generally found lacking in the literature.

To establish the hypothesis developed in this thesis, it will be necessary to initiate empirical research for different industries and segments supported by detailed case studies on organization entities in the channel in terms of how their strategies are evolving in view of the flux created by technologies such as the Internet. It will be useful to expand the perspective to include the manufacturer's long term objectives besides consumer needs and buying behavior. For instance, it is important to understand the cost tradeoffs in direct vs. intermediated channels, in terms of distribution and manufacturing costs. As markets move towards one-to-one marketing enabled by the Internet, it is possible that manufacturing costs may go up in the long run because of ever increasing expectations of consumers in terms of customization and delivery time.

This thesis also does not consider the transient dynamics of evolving channels. Issues such as channel conflict and diffusion of new technologies such as the Internet need to be studied in greater detail to understand why the existing channel structure may be different from the normative channel structure discussed in this thesis. Use of System Dynamics 87 simulation tools can help in understanding the interplay between various parameters that may otherwise be considered as 'independent' in a typical econometric model of marketing channels. A diffusion model such as the Bass diffusion model can possibly be applied to the framework developed in this thesis to understand why certain consumer segments will prefer certain channels and how it may change over time.

Finally, this thesis has primarily focussed on the impact of the Internet on the number of echelons in a distribution channel, ignoring to a large extent the impact on the number of intermediaries in a specific echelon (distribution intensity) or the exclusivity of the distribution channel. Further research is therefore required to understand in a more comprehensive way the impact of the Internet on these characteristics of distribution channels. 88

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