David J. Bryce © 2003 The “New” Economy: The Economics of Information MANEC 387 Economics of Strategy MANEC 387 Economics of Strategy David J. Bryce

David J. Bryce © 2003 The Structure of Industries Competitive Rivalry Threat of new Entrants Bargaining Power of Customers Threat of Substitutes Bargaining Power of Suppliers From M. Porter, 1979, “How Competitive Forces Shape Strategy”

David J. Bryce © 2003 Information and Things Historically, to get information about differences in prices, features, services, and support, you had to physically visit a variety of retailers Because the information is tied to the thing, consumers incur search costs Search costs insulate firms from aggressive pricing by distant rivals, allowing them to charge higher prices in local markets Margins depend on asymmetry of information Historically, to get information about differences in prices, features, services, and support, you had to physically visit a variety of retailers Because the information is tied to the thing, consumers incur search costs Search costs insulate firms from aggressive pricing by distant rivals, allowing them to charge higher prices in local markets Margins depend on asymmetry of information

David J. Bryce © 2003 Information and Things Every business is an information business (at some level) because information is the glue that holds value chains, supply chains, and organizations together Ubiquitous connectivity creates the opportunity to unbundle information from “things” Implications are revolutionary Every business is an information business (at some level) because information is the glue that holds value chains, supply chains, and organizations together Ubiquitous connectivity creates the opportunity to unbundle information from “things” Implications are revolutionary Source: Evans and Wurster, 1997

David J. Bryce © 2003 Richness and Reach An Application of Search Costs Historically, technology constraints have forced a tradeoff between richness and reach in information (diminishing returns to scale) –Reach — the number of people exchanging information –Richness — quality of information in dimensions such as accuracy, bandwidth, currency, customization, interactivity, relevance, etc. This tradeoff is no longer always necessary New constraint: Time and comprehension Historically, technology constraints have forced a tradeoff between richness and reach in information (diminishing returns to scale) –Reach — the number of people exchanging information –Richness — quality of information in dimensions such as accuracy, bandwidth, currency, customization, interactivity, relevance, etc. This tradeoff is no longer always necessary New constraint: Time and comprehension Source: Evans and Wurster, 1997

David J. Bryce © 2003 Richness Dimensions Bandwidth –Amount of information Customization –Match message to receiver Interactivity –Dialogue vs. monologue Bandwidth –Amount of information Customization –Match message to receiver Interactivity –Dialogue vs. monologue Reliability –Exchange between trusted individuals Security –Sensitive information in closed door meetings Currency –Timeliness of information Reliability –Exchange between trusted individuals Security –Sensitive information in closed door meetings Currency –Timeliness of information Source: Evans and Wurster, 1997

David J. Bryce © 2003 Network Effects in the Internet Positive feedback and network externalities –The value of a product to one user depends on how many other users there are –“Installed base” is a strategic imperative Lock-in and switching costs are the norm in the information economy – contractual commitments, durable purchases, brand specific training, search costs, loyalty programs “Winner-take-all” competitive environment leads to large, unassailable competitors and also-rans. Positive feedback and network externalities –The value of a product to one user depends on how many other users there are –“Installed base” is a strategic imperative Lock-in and switching costs are the norm in the information economy – contractual commitments, durable purchases, brand specific training, search costs, loyalty programs “Winner-take-all” competitive environment leads to large, unassailable competitors and also-rans. Source: Shapiro and Varian, 1998

David J. Bryce © 2003 Perception of Network Effects “Owing in part to economics of increasing returns, the revenue/profit streams that accrue, in time, to the Internet leaders … should be broad-based and recurring and the user reach supported by the leaders may be impressive (of Microsoft-ian and ATT-ian proportions or higher).” Morgan Stanley report, 1999 Source: Liebowitz, 2002

David J. Bryce © 2003 Conflicting Implications for Market Structure Breaking information from things decreases search costs and breaks up supply chains and value chains –“Disintermediation” allows customers to interact directly with manufacturers and wholesalers. –Massive divestment of functions and divisions within old economy firms Massive M&A activity by new economy firms –Network externalities –System competition –Positive feedback loops Breaking information from things decreases search costs and breaks up supply chains and value chains –“Disintermediation” allows customers to interact directly with manufacturers and wholesalers. –Massive divestment of functions and divisions within old economy firms Massive M&A activity by new economy firms –Network externalities –System competition –Positive feedback loops Source: Evans and Wurster, 1997

David J. Bryce © 2003 Which Market Structure Will Play Out? Network externalities (increasing returns) are not an either-or proposition – they range from strong to weak to non-existent E.g. Microsoft’s network externalities are strong and generate profitable results But generally, Internet firms have weak to non-existent network externalities resulting in –Lower search costs –Disintermediation and easy entry –Increasing competition Network externalities (increasing returns) are not an either-or proposition – they range from strong to weak to non-existent E.g. Microsoft’s network externalities are strong and generate profitable results But generally, Internet firms have weak to non-existent network externalities resulting in –Lower search costs –Disintermediation and easy entry –Increasing competition

David J. Bryce © 2003 Characteristics of Products that Promote Internet Transformation Size and bulk relative to value Immediate gratification factor (impulse buying) Perishability Experience goods and free-riding Thin vs. thick markets The issue of sales tax Size and bulk relative to value Immediate gratification factor (impulse buying) Perishability Experience goods and free-riding Thin vs. thick markets The issue of sales tax Source: Liebowitz, 2002

David J. Bryce © 2003 Products Compatible with E-tailing Low bulk/value, non-impulse purchase, non- perishable, non-experience good, thin markets Digitized products –Software, music, and movies –Intellectual property issues are critical Information –Airline, car, and hotel reservations, stock transactions, news retrieval, classified advertising Books and CDs Low bulk/value, non-impulse purchase, non- perishable, non-experience good, thin markets Digitized products –Software, music, and movies –Intellectual property issues are critical Information –Airline, car, and hotel reservations, stock transactions, news retrieval, classified advertising Books and CDs Source: Liebowitz, 2002

David J. Bryce © 2003 Profit Potential of E-Commerce Virtual storefronts have lower costs than brick-and-mortar storefronts Lower costs of Internet firms translate into lower profits: –Lower search costs causes increasing price elasticity of demand –In thin markets, Internet creates more rivals –Ease of entry increases rivals –Limited opportunity for differentiation –Increased price competition Virtual storefronts have lower costs than brick-and-mortar storefronts Lower costs of Internet firms translate into lower profits: –Lower search costs causes increasing price elasticity of demand –In thin markets, Internet creates more rivals –Ease of entry increases rivals –Limited opportunity for differentiation –Increased price competition