ELC 498 DAY 4 Capturing Value: Market Structure and Competition

Agenda Questions?? 3 rd Perspective Capturing Value: Market Structure and Competition

4 Perspectives 1. Technological Drivers Of Change 2. Creating Value: Economics Of Internet- based Commerce 3. Capturing Value: Market Structure And Competition 4. Creating And Capturing Value In The Supply Chain

Overview Capturing value is all about “who wins” in the economic markets Intense competition creates value for consumers Different Industries have different market structures Horizontal (chap 3) Vertical (chap 4) Of particular interest is markets that demonstrate DSIR (demand side increasing returns)

Conventional Factors Determine market structure Number of firms Size distribution of firms Nature of competitive strategies What is the optimum size for a firm in a given market? Economies of scale Big live … small die off Low Barriers to entry Many new entrants Bottom line What determines increasing returns (size, experience, technology) determines market structure

The eCommerce market Increasing returns are more affected by distribution than manufacturing 1. Design and development of website 2. Ordering process 3. Fulfillment and logistics Low barrier to entry Low cash needs Ability to outsource tech Results : Many (too many) entrants into the marketplace

Increasing returns? 4 Problems (not obvious) Customer service is harder and more expensive for eCommerce Certain business models have high organizational costs While ecommerce may reduce some transactional costs; larger reductions can be realized by larger infrastructures (i.e. centralized inventories Driving traffic to the website can be difficult and expensive High CAC and branding costs The strong get stronger and the weak perish Incumbency advantage Experience effects Brand building

eCommerce markets Information is also subject to increasing returns Consumption does not effect volume or value Encyclopedia knowledge creates an incumbency advantage Google, cnet, wikiopedia Positive feedback model Word of mouth (mouse) Experience branding Future results (oligopoly plus) Few large players Many fringe firms We are not there yet but are well on our way Failure to reach critical mass can lead to death spirals

Demand side increasing returns (DSIR) The product’s or service’s benefits to each user increases with the number of other users Creates a Winner take all market 2 sources of DISR Compatibility Network effects

Compatibility effects Computer programs and document formats Microsoft Word vs. WordPerfect VHS and Beta tapes BluRay and HD DVD Standardization benefits Open standards De facto standards

Network effects (full mesh)

Network effects (partial mesh)

Network effects (intermediary)

Network Effect (clearing house) Clearing House ABCDEF

eCommerce DSIR IM C2C auctions Peer to peer networks Clearing houses and payment systems

DSIR and Market structure Size installed base determines user acceptance High Switching cost deters user from switching between substitute products Players in a Markets that has large installed base and high switching cost tends towards a winner take all market structure “There can be only one”

DSIR feed back Technology is attractive to new users Technology gets larger Share of new purchases Installed base grows Technology has the largest # of users

DSIR example strategies Community building Product reviews Get big fast Lower cost – free? Co-location Brand building

Competition Many factors Highly concentrated industries Low switching costs on the web Everyone is a few clicks away Lower search costs High competition should lead to price convergence Local gas prices

Contestable markets New firm can enter market easily New (or existing) firm can gain market by offering competitive pricing Contestable markets should tend to the “law of one price” One would think that eCommerce is a contestable market

Price reality check Price dispersion for online products is high (~30%) Some is due to introductory pricing Gain DSIR attributes Some is due to electronics markets not reaching equilibrium (yet) Too early to tell eCommerce does not eliminate all sources of differentiation Quality, service & trust Site composition

Online vs. off line Competitive advantage Online Low cost leader Knowledge of customer behavior -> personalization Create new CA Product differentiation Offline Low cost leader Leverage existing CA Price (value) differentiation

Capturing value through pricing eCommerce brings Pricing that can be changed dynamically Pricing that can be tailored to individual buyers Buyers can negotiate pricing Groups of buyers can determine pricing Auctions are easy Ecommerce companies must be able to charge customers something approximating what the individual is willing to pay

Problems with fixed pricing All products marginal costs Fixed price assumes that the price exceeds marginal cost by a certain factor Fixed pricing assumes that all buyers have same willingness to pay There may be consumers they would be willing to pay for the product There may be consumers that are willing to pay mire than the marginal cost but less than the fixed cost What happens if the marginal cost decrease as volume of sales increases?

Problems with dynamic pricing Requires knowledge of consumer Some consumer remain anonymous Dichotomy of buyers having more product knowledge while supplier have more consumer knowledge Acquisition and Storage of consumer data is controversial Dynamic pricing my be illegal

Dynamic pricing examples Group discount purchasing Co-op Auctions (forward and reverse) Coupons and loyalty discounts Amazon charged existing customer more than new customers Revenue management systems Airline and hotels

Summary Online markets have greater variety than off- line efficiency matters (on-line and off-line) Some on-line markets are fragmented, others are concentrated DSIR is an important consideration Low Barriers to entry created fluidity on the market (Incumbents are unable to entrench) Market niches be less competitive There will be many innovative pricing schemes in future eCommerce markets