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Internet Commerce
• Products that lend themselves to the Internet.
• First, two types of Internet models
– Full Internet: no brick and mortar, only virtual. No
costs for warehouses, trucks, stores, salespeople,
and so forth. This was the original Amazon model.
– Partial Internet: Perhaps just for order taking (usual
warehouses, customers pick up from brick-andmortar retail outlet.
– Or some combination.
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Characteristics of Products that are Likely to
Determine the Extent of the Internet Transformation.
• Look to the mail order industry as a guide.
• Size and Bulk relative to Value
– Shipping costs would become very high relative to
the value of the product for bulky or cheap
merchandise, making it uneconomic to purchase
goods this way.
– Soil, canned vegetables, soda, and other similar
items seem like very poor candidates.
– Electronic equipment, well graded diamonds, frozen
gourmet food might be good candidates.
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Crucial Product Characteristics
• Perishability
– This is important due to the delay in shipping.
– You aren’t going to order hot food through the
Internet unless they have local delivery, as in Pizza
delivery.
– Milk and other perishables wouldn’t do well being
shipped nationally through normal shipping
channels.
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Crucial Product Characteristics
• Experience Products
– Products you need to touch, feel, see, and experience
before you buy.
– Automobiles are experience goods, as are many
other goods. For many individuals they need to
experience the particular car they plan to buy, not
just the same model at a dealership.
– Vegetables and meat are often purchased only after
inspection by consumer.
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Crucial Product Characteristics
• Immediate Gratification Factor (Impulse buying)
– Some products you see and what to have
immediately.
– They are often at the front of supermarkets near the
checkout stand.
– Internet makes you wait for delivery (except for
digital products, discussed below).
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The Role of Taxes
• There are essentially no sales taxes on Internet
sales.
• This gives Internet sales an advantage over
brick-and-mortar sellers that has nothing to do
with economic efficiency.
• If Internet sales were to become important
enough, more important that mail order, tax
differential would probably be eliminated.
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Internet Advantages
• Lowers cost compared to brick-and-mortar
sellers. Here is the original ideal:
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Just takes orders electronically and drop-ship.
No salesmen.
No warehouses.
No offices, or hardly any. Just management and
web design.
• The reality can be quite different.
• Why didn’t Internet firms follow this model?
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Types of Products Most Compatible with E-tailing?
• Digitized Products: no bulk, zero shipping costs,
immediate gratification.
– Computer software.
– Songs (when format issues, piracy, and copyright issues are
resolved).
– Videos (with same caveat)
– Information (databases, telephone numbers, and so forth)
– Books: when E-books become practical for most or many
readers.
• Other Information products: Auctions (Ebay), travel
agencies (Expedia, Travelocity), Ticket sales, news,
weather, etc.
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Markets likely to resist the Internet assault.
• Grocery Items : high bulk relative to value,
distribution systems likely to be inefficient,
many products are experience goods,
perishability problems.
• Automobiles: experience goods
• Furniture: experience goods, costly
shipping.
• Prescription Drugs: immediate need (instant
gratification.
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Majority of Markets
• Can use Internet for advertising,
information, maybe sales.
• Shoppers could then pick up orders at local
store – this only makes sense if the Internet
experience is faster or cheaper for
consumers as opposed to going through the
store.
• Current, relatively efficient distribution
systems not impacted.
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Internet Profits
• Why have they been so elusive?
– Prices have been too low in search of gaining
market and market share – flawed network
thinking.
• Too Much Investment
– Overly optimistic view of short term role of the
Internet.
• What should we expect?
– Next few slides show why margins should be
small.
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Meaning of Profit Margins
• In competitive industries, economic profits are
driven to zero for the industry (or at least for
potential entrants).
• This mean that the return on investment is equal to
the normal return in competitive industries (in
equilibrium). Less competitive industries can earn
above normal returns.
• The fact that there is a concept of ‘normal returns
on investment’ does not imply that there is any
such concept as a ‘normal returns on sales’!! The
return on sales depends on the value added.
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The Concept of Value Added
• Usually: The larger the investment as a
percentage of the sales revenue the larger
the percentage of total value of the product
sold that is created by the seller.
• This is the reason that supermarkets have
such low returns on SALES (but not
necessarily low returns on investment!)
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Implications for E-firms
• Internet firms, particularly full Internet firms, are expected
to have lower costs than brick-and-mortar firms.
• Who do Internet firms compete with? Brick-and-mortar
firms or other Internet firms? This is an important
question.
• If other Internet firms, then returns on sales will be lower
for Internet firms than the brick-and-mortar counterparts.
• If the competition is really between brick-and-mortar and
Internet firms, then profitability depends on who is more
efficient, and this will determine returns on sales. But in
the end, even if Internet firms are more efficient, return on
sales will be less.
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Advertising on the Net
• Original model was subscription based – AOL ISP
model with specialized content.
• ESPN, Wall Street Journal, Slate, and a host of
others tried this.
• Then advertising was added in, as in TV.
• Only WSJ and a few others stayed with
subscriptions. Others found that when they
charged user, number of users dropped
dramatically, hurting ad revenue and dashing their
hopes for large market share (they believed that
network effects made first movers the winners.
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Advertising on the Net
• Net firms thought they could be solely advertising
based.
• The TV model that they were thinking of was a
flawed model. It was due to unusual historical
factors, not economic forces.
• Pure advertising models almost never are used:
magazines, cable networks, newspapers, all use
both advertising and subscriptions.
• Based on these analogies, the model that will win
in the end almost certainly will be a mixture of
advertising and subscriptions.
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Advertising on the Net
• Net advertising revenues seem unlikely to be large
enough to support many sites.
• Banner advertisements are not going to be very effective.
Too small, too easy to avoid.
• Compare to TV ads: TV ads interrupt, have sound and
music, can provide an aura about the product. Until Net
Ads can do the same, they will never be as effective.
• Net ads do have an advantage of being very easy to
monitor (click-throughs) and sites can be very
specialized.
• Dot-com fever made the advertising model seem feasible
for a while, although even dot-coms went to TV to get
market share.
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Predicted Internet Advertising
Table 6.1: Advertising Cost Per Hour of Activity
Television
Internet
1. Hours Viewing Media per Day
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0.5
2. Size of Audience
265,000,000
132,500,000
3. Viewer-Hours per Day
1,060,000,000
66,250,000
4. Viewer-Hours per Year
386,900,000,000
24,181,250,000
5. Advertising Revenue
$50,000,000,000
$3,110,000,000
6. Price per Viewer-Hour
$0.129
$0.129
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Melt down
• What happened to cause the melt-down in Internet
stocks?
– Trying to sell products on the Internet that didn’t make sense.
– Belief that first to market and market share leaders get to take
away all the winnings (misapplying network effects stories).
• See “The great Net giveaway gimmick” as an example of the mentality.
– Installed base was used to determine stock valuations. As if
profit per user were assured.
– Too much investment lead to lower returns.
– Throwing out usual business rules: profits, business plans,
managers with experience.
– Cash rich net firms overspent on advertising and each other,
causing a bubble that was amazing while it happened.
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Too Much Investment
• Impact of ‘too much’ investment.
– As an analogy, even in the greatest oil find
imaginable, if firms have to bid on the fields,
and if there are many excited bidders, prices
can be bid so high that there are no profits after
the oil is developed. Look to the sale of
spectrum frequencies for an example.
– Additional investment depresses the prices that
can be charged the results of the investments
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The role of auctions
• Is Ebay successful because of auctions?
• Interactive Pricing (Auctions) versus Listed
Prices
– Who benefits? Is it better for sellers? Buyers?
Could it be better for both?
– Is this a form of Price Discrimination?
– Are we going to move to a world of auctions?
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History of Haggling
• Was common until recent times in Modern
Countries
• Why did it end? High cost of time
• Shopping with fixed prices is more
convenient than haggling.
• Will the Internet allow haggling without the
inconvenience? Perhaps, but to what
purpose?
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