Electronic Markets and Virtual Value Chains on the Information Superhighway

Electronic markets may soon affect the evolution of the national information infrastructure (NII), or in formation superhighway, as well as the emerging global infrastructure. As the NII is connected to consumers’ homes, market activity will rapidly expand. When this happens (most likely over a ten-year period), significant changes in the economics of marketing channels, patterns of physical distribution, and the structure of distributors may also occur. In this article, we draw on previous research on transaction costs and electronic markets to suggest that: (1) all intermediaries between the manufacturer and the consumer may be threatened as the NII reaches out to the consumer; (2) profit margins may be substantially lowered and redistributed; (3) the consumer will have access to a broad selection of lower-priced goods; and (4) there will be many opportunities to restrict consumers’ access to the potentially vast amount of commerce.

Central to the evolution will be the way in which the “market choice box,” the consumer’s interface between the many electronic devices in the home (television, telephone, and computers), the information superhighway, and the vast variety of market choices, will be implemented. Although many of these potential areas of restricted access are being debated in public policy arenas, the market choice box, a technology component, may become a critical component of free access and thus needs policy-makers’ scrutiny.

In the following sections, we examine electronic markets and the industry value chain from the perspective of transactions and transaction costs. We present a model of the NII that delineates key technology elements and stakeholders and identify several highly leveraged opportunities for redefining industry value chains. Finally, we suggest issues that executives and policymakers should focus on in the near future.

New Links in the Value Chain

It is becoming increasingly difficult to delineate accurately the borders of today’s organizations. Driven by IT’s ability to produce ever cheaper unit costs for coordination, organizations are implementing, increasingly rapidly, new links for relating to each other. These links take many forms, such as electronic data integration, just-in-time manufacturing, electronic hierarchies and markets, strategic alliances, networked organizations, and others. The new forms indicate an ongoing transformation of value chains due to technological change.

The proposed national information infrastructure presents an idealized model of everything connecting to everything else, at an extremely high bandwidth and at relatively low user costs. The conceptual model supports a feasible scenario of what will happen to organization and industry value-added chains (i.e., the collection of companies involved in producing, distributing, and selling a related set of products from raw material to the consumer), when the NII capabilities become real (see Figure 1).

Our analysis of transactions gives us a framework for examining the potential changes in organizational and industry value chains. Chandler notes that “Every coordinative activity that improves organizational efficiency, speeds up flow through the system, or permits a more intensive use of the factors of production is likely to improve the performance of the economic system.”1 Williamson similarly points out: “The modern corporation is to be understood as the product of a series of organizational innovations that have had the purpose and effect of economizing on transaction costs.”2

What has been said about the corporation seems equally applicable to the industry value chain, where Michael Porter, who uses the term “value system” for industry value chain, notes: “Competitive advantage is increasingly a function of how well a company can manage this entire system.”3 If it is true that the NII will dramatically reduce the costs of information and communications (i.e., coordination costs), a fundamental restructure of entrepreneurial opportunities and roles within industry value chains will result. Within a given value chain, each business will search for transactions that will provide advantage over its competitors and competitive differentiation to explore the NII’s potentials. For example, one or more of the organizations within an industry value chain may be bypassed when the NII provides the links for a new pattern of transactions. An Office of Technology Assessment report states:

Networking technologies can greatly reduce the costs entailed in exchange transactions. As these costs decline, many business activities previously carried out within vertically integrated firms will be shifted to the marketplace. . . . The network will, in many instances, serve as the market. When this occurs, market structure will depend as much on network characteristics and the economies of networks as it does on relationships among firms.4

A National Information Superhighway

In 1990, Senator Ernest Hollings argued before the Senate Commerce Committee in support of information infrastructure legislation. His argument has served as justification for rapidly moving legislative, regulatory, and commercial activities, as the NII starts to take shape:

Simply put, fiber to the home, school, and business is an essential infrastructure for economic development in the Information Age of the twenty-first century, just as railroads were in the last century, and highways were in this century. As the economy shifted from agrarian-based to industrial-based, our ability to move goods via railroads at first, and highways later, proved essential. Now we are shifting toward a service-based economy in which the ability to transport information will prove essential.5

While momentum toward an infrastructure increases, various stakeholder groups are debating many questions about the NII. What and for whom are the benefits of the infrastructure? Is the NII moving goods, moving ideas, or both? Can one extrapolate benefits from the railroad, highway, and aviation infrastructures, where both physical goods and information (for example, mail, bills of lading, etc.) are transported to the NII, an infrastructure that transports only information, as early forms of the information infrastructure have done (e.g., the telegraph, the telephone)? Who are the direct and indirect beneficiaries of the increased economic activity presumed for the NII? We examine these questions in the context of electronic markets and the value system from the manufacturer to the consumer.

Current State of the NII

Vice President Albert Gore suggests that the vision of the infrastructure can be simply stated as the linkage of all information users with all information providers through some form of market mechanism.

Anyone who wants to form a business to deliver information will have the means of reaching customers. And any person who wants information will be able to choose among competing information providers, at reasonable prices. That’s what the future will look like — say, in ten to fifteen years.6

Today, there is no integrated NII. On the one hand, the current NII is a wide-ranging debate among many stakeholders about the future; on the other hand, the NII is a set of services provided by independent information infrastructures (telephone, television, cable, and other industries). All are moving inexorably to interconnected digital services to connect business, government, and individuals at home. All infrastructure providers as well as many IT providers want to participate in the integration of the computer, the telephone, and the television in the home. Numerous mergers and strategic alliances have been formed on the assumption of sizable economic return — mergers include AT&T and McCaw Cellular, US West and Time Warner, Bell South and Prime Management; strategic alliances include Microsoft and AT&T; Cox Cable, the Atlanta Journal and Constitution, and Prodigy; Lotus Development and AT&T. And the list continually changes and expands.

Meanwhile, the Internet, a subset of the NII, gives its users a broad set of services: e-mail, information access to libraries, specialized databases and dialogues in many disciplines, and new, highly innovative ways to improve accessibility to information sources in the United States and throughout the world. The Internet may be viewed as a collection of value-added services that are transported over the telephone and cable networks. Its growth rate — already hyperactive — seems to be accelerating more rapidly as commercial providers and users discover its potential and the media focus on it. The Boston Globe reported 2,300 newspaper and magazine articles about the Internet in the first nine months of 1993.7 And Internet Technology noted: “As of May 1994, the Internet consisted of over 31,000 networks. . . . The number of computers connected through the Internet exceeds two million. . . . Over 20 million people can be reached by electronic mail and have access to resources via the Internet.”8

Despite the heightened focus of government, industry, and public advocacy groups, the direction the NII will take as it moves toward a more generally shared vision is still unclear. Many papers, books, and symposia are currently devoted to debating what the NII will ultimately look like. We have made several assumptions about the NII for our analysis:

1. Everyone and every organization will be interconnected.
2. The connections will be at a very high bandwidth rate, greater than a billion bits per second, and sufficient to carry out interactive multimedia transactions.
3. Cheap, high-speed computation will facilitate the implementation of low-cost coordination transactions.
4. A market choice box, the interface between the consumer and the NII, will provide the interactive capabilities for making free market choices easily and intuitively. Because of the many conflicting vendor interests in the development of the market choice box, its implementation will be uneven and its maturity will be difficult to predict.
5. There will be no favoritism designed into market access to the NII.

Electronic Markets and Hierarchies

Economies have two basic mechanisms for coordinating the flow of materials or services through adjacent steps in the value chain — markets and hierarchies.9 Williamson categorizes transactions into those that support coordination between multiple buyers and sellers, i.e., market transactions, and those that support coordination within the firm, as well as the industry value chain, i.e., hierarchy transactions.10 Williamson points out that the choice of transaction will depend on a number of factors, including asset specificity, the parties’ interest in the transaction, and ambiguity and uncertainty in precisely describing the transaction.

The price a product is sold for consists of three elements: production costs, coordination costs, and profit margin. Different scholars use different terms to describe coordination costs: Chandler describes them as administrative costs, Williamson as governance or transaction costs. We refer to the definitions of production and coordination costs that Malone et al. use:

Production costs include the physical or other primary processes necessary to create and distribute the goods or services being produced.

Coordination costs include the transaction (or governance) costs of all the information processing necessary to coordinate the work of people and machines that perform the primary processes. For example, coordination costs include determining the design, price, quantity, delivery schedule, and similar factors for products transferred between adjacent steps on a value chain.11

Firms will choose transactions that economize on coordination costs. As information technology continues its rapid cost performance improvement, the unit cost of coordination transactions will approach zero, thus enabling the design of innovative coordination transactions to fit new business needs.12

Malone et al. argue that organizations increasingly coordinate their activities electronically, and that this coordination takes the form of single-source electronic sales channels (one supplier and many purchasers coordinated through hierarchical transactions) or electronic markets.13 They also argue that electronic markets are a more efficient form of coordination for certain classes of product transactions, those where asset specificity is low and where products are easy to describe.14 Thus, with cheap coordinative transactions, interconnected networks, and easily accessible databases, there would be a proportional shift of economic activity from single-source sales channels to electronic markets, for the following reasons:

1. Lower coordination costs favor electronic markets. Companies need to achieve a balance of production and coordination costs; those that increase economic performance will be evolutionary survivors. Markets have been characterized by low production costs and high coordination costs, and hierarchies by high production costs and low coordination costs.15 However, along with lowering production costs, information technology has and will continue to lower overall coordination costs. Thus lowering coordination costs decreases the importance of those areas where markets have a disadvantage and so favors markets.

2. Low computing cost can expand products that favor market transactions. Products that are easy to describe favor electronic markets. Low-cost computation can simplify complex product descriptions — for example, stock index funds, which, in the case of the New York Stock Exchange, require averaging several thousand securities daily into one easy-to-describe product.

Asset-specific transactions, those that favor hierarchies, can be narrowed by the use of electronic technology.16 For example, the personal computer, on the surface a highly asset-specific device (for example, when adding a printer to the configuration), has been successfully sold through mail-order channels by companies like Dell, Gateway, and Compaq that have been able to lessen product specificity. They have initiated “help desks” that consumers can call for information and are now installing “plug and play” configuration software to further simplify the consumer’s life.

Thus more product transactions over time will favor electronic markets, and more purchasers will choose to purchase through electronic markets than through hierarchical arrangements.

3. There will be an evolution from single-source sales channels to markets. Malone also suggests evolutionary paths for electronic single-source sales channels and markets.17 Electronic single-source sales channels will evolve from separate databases within the firm, to linked databases between firms (EDI), to shared databases between firms. Electronic markets will evolve from electronic single-source sales channels, to biased markets where the market maker is one of the providers and uses the market transaction mechanisms in its favor, to unbiased markets, and finally to personalized markets, where the customers can use customized aids in making their choices. A customized aid is an expert system, like American Airlines’ SABRE CRS, to help make a decision.

4. There will be trade-offs in market participation. A company with a successful sales channel will set up an electronic market when the potential profit from an increased volume of market transactions is greater than the potential profit loss from having to sell at a lower price because of the effects of the electronic market. Similarly, a single-source sales channel will enter an electronic market only when the total share of market transactions available (at prices the market will allow) is greater than the profit generated by the channel at its higher price margins.

Expansion in Electronic Single-Source Channels

The rapid expansion in electronic single-source sales channel activities is well described in the popular business press. However, contrary to prediction, comparatively little has been reported on expansion of electronic markets. There are several explanations for this:

1. Impact of interorganizational value chains. Companies readily see the opportunities in electronic interorganizational value chains for improving their competitiveness as they focus on higher-quality products, increased customer satisfaction, and business reengineering. Thus they choose hierarchical arrangements rather than lower cost market transactions with less control of the variables noted above.

For example, in electronic supply-chain integration, buyer-supplier links such as electronic data integration transactions produce inventory and coordination savings for large purchasers, and the suppliers are forced to accommodate. These links are found in retailing, such as WalMart’s supply chain, and in the relationship between auto manufacturers and their suppliers.18

Processes that are highly coordinated to reduce process and inventory time, i.e., lean production,19 also require tight electronic linkage between firms. Asset-specific relationships based on assured delivery and very high quality steer the firms away from electronic market transactions and in the direction of a small number of “partnerlike” suppliers. For example, as Xerox moved to its high-quality, just-in-time processes, it reduced its supplier base from several thousand to several hundred. Whirlpool Corporation’s CEO David Whitwam explains this logic: “Finally we are moving toward a significant consolidation of our suppliers. . . . We want to have agreements that give us access to supplier technologies so that we can work together on process improvements in all of our plants. That’s difficult to do with a broad supplier base.”20

Electronic alliances provide another example. Single-source sales channels for travel agencies such as Rosenbluth Travel have expanded their business through agency partnerships in countries where they share a common process and database for tracking customers around the world, while providing them with the lowest prices and emergency services.21 Rosenbluth Travel is an example of the last evolutionary stage predicted for electronic single-source sales channels, a shared database between partners.

2. Fear of profit margin deterioration. Firms are very cautious about giving up their single-source sales channel profit margins, until a virtual market has clearly been created with enough participants to force their entry. This is particularly true when a relatively small number of very large corporations control a market, where each would risk sizable market share and profit margin in an electronic market. There is evidence, as in the case of the electronic markets for travel reservation systems, that the profits of the former sales channels (the airlines) are drastically reduced, while the profits of the market maker (APOLLO and SABRE, for example) remain high. Even the market-maker owners, American and United Airlines, have not been able to price tickets for their own airlines at satisfactory margins.

Bakos analyzes why the electronic market effect drives profit margin from the supplier: “In price competitive markets, even a small cost of search on the buyer’s part may enable sellers to maintain prices substantially above their marginal cost: in this scenario, the introduction of a market system providing price information can dramatically reduce seller profits and increase buyer welfare.”22

Bakos notes that this effect, which is supported in economic theory, can be anticipated in undifferentiated markets (for example, commodity markets) and cites the example of Reuters, Quotron, and Telerate, which all established markets in U.S. government fixed-income securities, leading to a reduction in trader profits from the large bond dealers.23 He also developed mathematical models for differentiated products where price and quality, for example, are two consumer choice variables and typify the industry value chains we are concerned with. He comments: “An important implication of this analysis is that electronic market systems providing product and price information may generate substantial allocational efficiencies by enabling customers to locate suppliers that better match their needs.”24

We need more evidence to further validate the “market maker effect” — the phenomenon in which the consumer does very well, producers lose their profit margins, and the market makers gain the remaining profits. This effect suggests that producers may find it hard to generate sustainable profits without finding new strategies for product and service differentiation.

Despite the profit losses, electronic markets continue to expand in financial markets, commodities,25 and, as previously noted, in the travel industry. Electronic markets have also expanded into niche markets where there are no large single-source sales channel suppliers with high market share to protect, such as spare parts for airplanes.

Schwab’s Onesource mutual fund market shows further evidence of the market-maker effect. Onesource’s equity in mutual funds has grown rapidly to $10 billion in assets.26 The mutual fund industry sees the market maker, Schwab, threatening to grow too large and gain control of a significant share of its operating margin. (A typical no-load fund receives a .5 percent fee for assets it manages for customers. To belong to Onesource, the fund pays Schwab half of this fee (about .25 cents for each dollar of equity.) The four largest no-load funds currently have around $700 billion in assets under their control. Movement of only the $10 billion currently under Schwab control represents a $25 million shift in operating margin to Schwab. For protection, Fidelity, the largest of the no-load funds, has set up an equivalent market, and no-load purchasers can now buy from several smaller markets as well.

Thus the market-maker effect may threaten the mutual fund industry’s profits in the same way it did in airline reservations. However, it may require competitive market makers in no-load funds to prevent market deterioration in no-load funds. Time will tell how strong the market-maker effect will be in the mutual fund industry, but the financial stakes are clearly very large.

· Reaching the Consumer.

The consumer who purchases traditionally through retailers is a prime candidate for an electronic market. The rapid growth in catalogs and cable shopping channels indicates that: (1) there are many products that meet the criteria for electronic markets — low asset specificity and ease of description; and (2) consumers are willing to buy these products without going to a retail store. Both these trends are causing retail market erosion and illustrate how electronic markets may affect consumer markets.

Catalog marketers such as Lands’ End cumulatively sell an enormous amount of merchandise; 10,000 mail-order companies sold $51 billion worth of goods through catalogs in 1992.27 Because catalog sales must have the same characteristics as electronic markets, i.e., they must be easy to describe and not very asset specific, they indicate the wide product varieties amenable to electronic markets.

Home shopping through TV is a rapidly growing business accounting for several billion dollars in sales in 1993. It represents a very limited market in which the consumer sees different kinds of merchandise but cannot compare merchandise within a class, thus preserving high profit margins for the channel owner. This limited market form, while dictated by the current capabilities (choice, interactivity, and display quality) of the cable system, also preserves maximum price differentiation for the home shopping networks. Home shopping, however, demonstrates the consumer’s willingness to buy goods over electronic channels, within the limitations described, and also identifies many products that meet the electronic market test.

However, until technology opens the door, electronic markets or sales channels will be unable to make significant inroads with the consumer. Homes must be wired for interactive, high-quality videos so consumers have a friendly, flexible way to access the market. Until then, the retailer will continue to be the traditional consumer market, buying and displaying merchandise from multiple suppliers. But the required technologies are evolving rapidly, and the NII represents the organizer of these technologies. There seems little likelihood of significant change until the NII connects consumers to the industry value chain.

Industry Value Chains

In this section, we examine how transaction patterns may change when the NII is implemented and how selling prices will be affected. We consider only industry value chains that terminate with the consumer, as contrasted with intermediate goods value chains (see Figure 1).

The first chain in Figure 1 is the traditional chain of producer, wholesaler, retailer, and consumer. When the value addeds are summed, the consumer pays $52.72 per shirt. An alternate value chain bypasses the wholesaler and results in a price to the consumer of $41.34. The consumer’s savings are substantial, about 28 percent. In reality, because the wholesaler’s costs are eliminated, the retailer can eliminate some of its profit margin, further reducing its selling price and the cost to the consumer. When appropriate information technology can reach the consumer directly, as in the third chain, the manufacturer can use the NII to leap over all intermediaries. The consumer’s purchase price for the shirt is $20.45, and the net savings is about 62 percent. The manufacturer will surely try to retain a portion of these savings, unless market forces make it impossible.

In an alternative scenario, a market maker would provide the consumer with access to a number of shirt manufacturers. In this case, the electronic market effect would drive costs down to those of the lowest cost producer, thus reducing the manufacturer’s ability to appropriate a share of the savings. Each manufacturer’s profit margins would likely shrink. The price reduction would be balanced by the market maker’s small profit on each transaction.

In still another scenario, the consumer could easily access a sufficient number of single-source sales channels through a market choice box or an interactive agent to search shirt manufacturers for a suitable shirt. In the latter scenario, the market-maker effect may give the consumer a minimum price, but the market maker would not have a significant transaction profit.28

The NII from an Industry Value Chain Perspective

We have described how a value chain reconfiguration may result when the consumer is interactively connected to the chain, with potentially substantial savings in transaction costs and significant price reductions for the consumer. Next we examine relevant elements of the NII and discuss several areas where companies can realize opportunities to economize along the industry value chain.

Figure 2 shows the various stakeholders and their connections to the NII. (Because much electronic commerce requires transportation of both physical goods and information, a physical transportation infrastructure is assumed but not shown.) The information highway infrastructure connects:

• Producers of information, including computer software, books, movies, music, and the like. All of these can be maintained in digital form and transmitted over the NII on demand with little or no physical inventory movement.
• Producers of physical goods, including all manufactured goods now sold through catalogs and those in which computer technology can simplify product complexity and reduce asset specificity.
• Electronic retailers, differentiated into specialty retailers like Blockbuster, or multiproduct retailers like Lands’ End, Sears, Macy’s, and so on.
• Electronic markets, expanded by market makers to include the travel and financial industries and specialty niches (for example, shirts, personal computer software, or baseball cards).
• Physical distribution networks, simplified to move from the manufacturer to the consumer directly, or coordinated by electronic retailer or market-maker transactions. The future delivery system might resemble the process that catalog vendors use now, mostly via Federal Express and United Parcel Service. When next-day delivery is satisfactory, such companies can provide the desired service. When a consumer requires faster delivery, such as when ordering a week’s groceries, variants like picking them up at the supermarket depot will emerge.
• Electronic channels, i.e., the cable, telephone, cellular, and electric utility industries that can all provide access to the home. Although a choice of electronic channel is still limited, market dynamics are unfolding rapidly (as, for example, in wireless channels), making predictions of the ultimate number of channels difficult.
• The market choice box, where a vast amount of electronic commerce will be channeled and controlled. It is a server that manages the configuration of workstations, telephones, and TVs in the home, and provides a telecommunications interface to those channels that directly reach the home (see Figure 3). The box will present a choice of markets and other activities such as entertainment, shopping, surfing on the Internet, or getting health information. How the primary graphical user interface (GUI) will be designed is anyone’s guess. What is important is that it not bias the consumer to one choice over another, as the initial airline reservation systems did for flight choice. Gilder has suggested that the ideal GUI may be a newspaper format, an interface designed for human interaction that has passed the test of time — we read a headline, skip to sports, back to the financial page, advertisements catch our attention, and we go deeper into them to get more product information.29 The primary GUI may also be adaptable to our life styles; each class of market choice may require a GUI to help explore its potential.

A possible metaphor for the market choice box is Magic General’s Telescript user interface. Wired has reported:

The interface has evolved to a geographical depiction of a portion of cyberspace. . . . Those who have read Neal Stephenson’s “Snow Crash” will instantly see its relationship to the “Metaverse” depicted therein — a virtual world where one can conduct all sorts of transactions, gather objects, and above all, maintain a sense of place. To buy things, go Downtown and into the electronic shopping mall. To scan newspapers, go to the Newsstand. Eventually the local pizza shop will show up on your personal Main Street.30

Such an interface would, for example, let the consumer put an interactive agent into the Travel store on Main Street that would purchase flight tickets and act as a pseudo-electronic market potentially bypassing APOL-LO, SABRE, and the travel agents. (One can speculate that a user interface owner, such as General Magic, would like to appropriate a portion of the resulting value chain and market-maker savings rather than share them with the consumer.)

Thus the market choice box and the standards associated with market choice (labeling of catalog items, marketing of client/server software for products such as Telescript) can all affect the openness of information and market access.

• The consumer — the wild card. Transaction cost theory requires cost savings that satisfy both parties in the transaction. An Office of Technology Assessment study describes a consumer purchase from a transaction cost perspective:

Consider markets in the context of a consumer buying a high-end stereo system. The buyer mulls over the features that are most important — wattage, audio performance, appearance, size, speakers, CD player, tape deck, and cost. There may be hundreds of dealers to choose from. The consumer reads catalogs, compares specifications, consults Consumer Reports, calls for price information, and visits dealers to compare models and prices. The search can take hours, days, or weeks. The time spent in research, comparative shopping, and making the deal are the transaction costs, as are the expense for fuel, wear and tear on the automobile [“as well as the psyche” — author’s comment], magazine and catalog purchases, and telephone charges.31

The potential changes in consumer behavior as he or she takes advantage of the cost opportunities the NII makes possible are on such a large scale, and the electronic transaction capabilities currently available so rudimentary, that our understanding of what the consumer will do is, at best, cloudy. We have some evidence that consumers will choose alternative forms of transactions (catalog and TV shopping networks) over retail store transactions, in favor of price, high quality, selection choice, and time savings.

An example of these developments, Peapod, a supermarket home-shopping service, is available now in two cities: at Safeway Stores in San Francisco and at Jewel Supermarkets in Chicago. (Peapod will soon enter the Boston market as well.) Customers (more than 2,500 in San Francisco and 5,000 in Chicago) pay $30 per month for the shopping service. They are given software for Mac and PC/Windows environments and can request deliveries, same day or ahead of time (within ninety-minute-delivery periods). Using the workstation, the customer can shop by aisle or by item name, develop personal lists, select delivery times, and specify items, for example, four bananas — two green and two ripe (there is a specially trained produce shopper who will carry out the request). How do people justify the expense of Peapod? The dollar value of working parents’ time is one way; and they can avoid having to manage small children through the supermarket. Peapod’s marketing manager suggests that people can pay for the service just by eliminating children’s “bribes” for good behavior while shopping.

Value Chain Opportunities and Risks

Based on our analysis, we have found four areas of opportunity and risk for stakeholders in the NII.

1. Benefits to the consumer. The consumer will have free market access to all suppliers willing to pay an interconnection cost — i.e., single-channel suppliers such as Lands’ End and electronic market makers such as Macy’s. The consumer will have maximum choice at lower price. If and when interactive agents are feasible, the consumer may have access to a market price without market-maker profits attached, but with the more efficient level of market pricing from the single channel suppliers.
2. Lower coordination costs throughout the industry value chain. Electronically linked producers and retailers will be able to lower their costs by reducing intermediary transactions and unneeded coordination because of electronic transactions directly with the consumer.
3. Lower physical distribution costs. Delivery costs will be minimized in two ways. First, information will be transmitted electronically, and much lower electronic distribution costs will be substituted. Second, as each element of the industry value chain is bypassed, a physical distribution link and related inventory carrying costs will be eliminated (see Figure 1, value chains 2 and 3).
4. Redistribution and potential reduction in total profits. The lessons of the airline reservation systems, the initial behavior of Schwab’s Onesource, and market economics indicate that many companies will need to face smaller profit margins. Such smaller profit margins may be compensated for by increased volume.

Issues for the Future

Finally, we examine two areas that policymakers and managers need to address when considering the possibilities of the NII — freedom of market access and the potential for value chain reconfiguration.

Market Access

Because of the vast amount of economic activity that will take place on the NII when it is fully implemented, policymakers need to set guidelines for the three areas where access may be restricted:

• The Electronic Market. If the market maker owns or has a substantial interest in any suppliers, it can bias the market in their favor, and both the consumer and other suppliers will be disadvantaged. In the airline reservation system, the airline market maker was stopped from continuing this tactic.32

• Electronic Channels. If the owner of a physical communication channel such as TCI, a long distance carrier, or a regional telephone company restricts access to any market channel because of interest in other specific market channels, it limits a consumer’s free access. The potential, but dissolved, TCI-Bell Atlantic merger posed such a threat, since both own electronic channels into the home, and TCI had substantial interest in market suppliers of entertainment programming and home shopping. Thus they could have restricted access to producers, retailers, and market makers to suit their own economic interests. In addition, the channel owner, which also has a monopoly on supplying information to the consumer, can keep access costs unnaturally high and curtail the rate of technology advancement, as when AT&T maintained a total monopoly in telecommunications.

Regardless of how many channels are connected to consumers’ homes, for the electronic market effect to occur, those channels must not limit or control access to the product or service providers that want to reach the home.

· The Market Choice Box.

By design, the market choice box can inhibit access to or for the consumer. It is not at all clear that the hardware processor, operating system, or other architectures that have dominated the PC evolution will maintain that status on the NII. The computing capabilities and innovation required in an operating system and user interfaces for the interactive multimedia may result in new designs. Dominant architectures, such as IBM’s in the 1960s through early 1980s and now Intel’s and Microsoft’s, have demonstrated the economic benefits of ownership most clearly. However, these architectures were limited in their revenue potential to the information industry, whereas the architectures that may control electronic transactions on the NII may have the ability to tap a vastly larger revenue stream of retail transactions to the consumer. Openness then becomes not only desirable but essential. However, we need to understand what openness means in terms of the market choice box.

Consider a market choice box that comes with a client-user interface (such as General Magic’s Telescript); because it’s easy to use and has value to the consumer, it becomes the dominant user interface. It can constrain free access in the following ways: (1) by not providing standards so other vendors can produce Telescript-like active agents, thus restricting consumer market choice; (2) by selectively controlling to which consumer product suppliers it will license server software for search and completion of market transactions; (3) by not licensing standards so other vendors can produce server software capable of handling its active agents; and (4) by using market power to ensure that all market choice boxes come equipped with its user interface. At this time, we know little about General Magic’s product capabilities and market intent, but it is useful for our analysis, since it represents a potential market choice box that can both enable and restrict access to the consumer.

In summary, stakeholders in the NII evolution need to think about the consequences of market constraint, and what legislative and other policies are needed to ensure a fair playing field. Further, stakeholders, such as consumer goods manufacturers, have as many interests in this evolution as do telecommunications and information technology companies.

Value Chain Reconfiguration

All the stakeholders in the industry value chain must consider whether their place in the chain is threatened and, if so, what long-term strategies to experiment with. Those in the consumer value chain need to understand under what conditions the consumer will prefer to purchase from single-source suppliers, brokered electronic markets, and intelligent agent proxies for electronic markets. To do so, they must learn how to use the NII in its current rudimentary form and, as its capabilities increase, begin to test their strategies more actively. They need to decide which technologies are crucial for their objectives and follow their progress closely. Finally, they need to follow electronic market implementation carefully to learn how the market-maker effect will redistribute profit margins.