Question

Explain why the cost structure associated with many kinds of information goods and services might imply a market supplied by a small number of large firms. (At the same time, one internet business such as grocery home deliveries have continually suffered steep losses regardless of scale. Explain why.) Could lower transaction costs in e-commerce ever make it easier for small suppliers to compete? Network externalities are often an important aspect of demand for information goods and services. (The benefits to customers of using software, participating in electronic markets, or using instant messaging increase with the number of other users.) How might network externalities affect firm operating strategies (pricing, output, and advertising) and firm size?

Answer 1

I need to be careful not to give you straight answers. I'm giving you some rough ideas from which you can easily put together a rational answer.

Primarily because the start up costs of these kinds of industries are very high. Equipment, plant, and skilled labor are expensive.

Constant expansion of product lines. This field moves rapidly. Resources must always be present to skilfully adapt to rapid market changes.

Massive competition, including powerful competition abroad. This is an easy one - the big firms can go head to head with the major Japanese giants.

Constant research and development. This is expensive, especially in the experts you must hire to make the investments here worthwhile.

"Bundling of information goods": This means that while it is expensive to start up, once you're there, it costs almost nothing to make one more piece of information. Hence, large scale works. Revenue is increased here through bundling through volume. The more that can be bundled, the higher the profits. Clearly, such large scale data creation is done best by large, centralized firms.

All of these cost a fortune, making it easier for an oligopoly to dominate this field.

Electronic commerce, or eCommerce, is conducting business over the Internet. Usually it refers to buying and selling goods and services, and transferring funds digitally. There are many benefits to eCommerce business, not the least of which is reduced transaction costs.

When offline stores calculate transaction costs, they have to factor in countless business expenditures along with the actual number of transactions. When there are fewer transactions, the cost of per transaction is higher. On the flipside, transactions arriving in high quantity can overwhelm your personnel and distributors. In an eCommerce business, the transaction cost is the same across the board, whether one order or thousands come in.

Electronic selling nearly eliminates processing errors that run rampant with human processors. This translates into less wasted time solving order and invoice problems. Although inaccuracies do not incur fees or penalties, they do take up considerable employee time and energy. ECommerce frees up staff members to focus on profit-generating activities.

The money received for every transaction will pay for the item; it will also contribute to the salesperson’s salary, credit card fees, lease on storefront, electricity, telephone, heating/cooling, taxes, displays, repairs and maintenance to the building. However, the money received for an eCommerce transaction pays for the item, web hosting, shopping cart software, distribution and little else. The cost overall of maintaining a virtual store is far less than that of a brick and mortar store.

An eCommerce business is able to reduce labor and other costs in many areas, including: document preparation, reconciliation, mail preparation, telephone calling, data entry, overtime and supervision expenses. EBusiness can help manage operating costs in many areas, thereby reducing the cost of individual transactions. The use of email and electronic invoicing are a tremendous savings over the traditional methods.

Use of the Internet for B2B e-commerce offers three main categories of value: reduced transaction costs, marketplace efficiencies through reduced prices or better matching of surpluses and shortage, and supply chain benefits. Within each category, the value will differ from company to company. Thus, before designing an e-commerce strategy, a company must carefully analyze the value provided by each category as well as the effort involved in deriving this value. Reducing transaction charges by using the Internet is relatively easy because it can be accomplished by implementing the technology; little strategic or organizational restructuring is required. The benefits of going online in this category will be less for companies with existing EDI systems and greater for companies currently conducting many small transactions mostly via paper/phone/fax. Price reduction through market efficiencies can benefit companies in industries requiring limited buyer/seller qualification and exhibiting a fragmented market with many players on the buy or sell side. Using the Internet to reduce supplier prices is unlikely to provide sustainable value in industries where supplier qualification is required or where long-term contracts predominate. In fact, a focus on price reduction may hurt long-term supplier relationships, inhibiting future collaborative activities. Industries that are highly fragmented can benefit greatly from online marketplaces that aggregate demand and smooth order variability—capabilities that reduce overall supply costs and lead to sustainable improvement. Potentially, the greatest area of value for market efficiencies is matching surplus supply/capacity with unmet demand. This area is particularly suited for companies with a high level of flexibility, which allows them to pool and absorb variable demand from customers. Supply chain benefits from B2B e-commerce are likely to be greatest in industries with complex supply chains, long delivery lead times, low inventory turns, low supplier visibility, little collaboration, or short product lifecycles. These benefits arise primarily from the Internet’s ability to enhance visibility and facilitate collaboration within a supply chain. Supply chain benefits remain the most difficult to realize given the high degree of strategic, IT, and organizational restructuring required. Companies with strong supplier and customer relationships and technologically enhanced transaction processes such as EDI can most easily extract supply chain benefits from B2B e-commerce. Companies that are weak in these areas, on the other hand, must address key strategic, IT, and organizational requirements before they can extract any benefits from B2B e-commerce. For these organizations, moving the supply chain online will likely be a time-consuming and expensive process. But failure to move on this front will only put them farther behind the leaders in the long run.

Network externalities are playing an increasingly important role in the economy, and they have significant implications for firms’ marketing strategies.

the economy becomes more interconnected, more products in computing, consumer electronics, and telecommunications industries exhibit network externalities (Yoffie 1997).1 Positive network externalities exist when a customer’s utility for a product increases as the number of customers who use identical or compatible products increases. Some examples of products with network externalities include digital videodisc players, digital cameras, instant messaging systems, interactive televisions, and MP3 players. Given the increasing importance of network externalities in the economy, extensive literature in economics has examined the strategic and welfare implications of network externalities (e.g., Economides 1989; Farrell and Saloner 1986; Katz and Shapiro 1986). A consistent finding in the literature is that network externalities alter customer behavior (e.g., before adopting the product, it is rational for people to wait for others to adopt the product) and have important implications for marketing strategy.

When the utility of a product to each user in a network depends on the number of users, the product exhibits direct network externalities (Katz and Shapiro 1986). For example, the utility of a fax machine is nil if no one else has one. As the number of people (n) who own fax machines increases, the utility of the fax machine to each user increases in proportion to the number of possible two-way connections, n (n – 1).

Positive effects of network externalities. Given the important role of the installed base for products with network externalities, a pioneer’s product may achieve market power through positive feedback (Arthur 1989). A large installed base attracts more developers of complementary and compatible products, thereby enhancing the utility of a pioneer’s product and speeding adoption (Choi 1994). Adopters invest in learning to use the product (e.g., videogames, software) and/or in complementary products (e.g., CD music titles for CD audio players), which results in lock-in and prevents defections to offerings of later entrants . In addition, products with network externalities are sometimes characterized by a standard (e.g., CD audio standard). The emergence of a standard reduces uncertainty about the eventual size of the network, thereby inducing earlier adoption by customers and spurring the development of complementary products. Thus, the pioneer may be able to set the standard and draw customers to its network, resulting in long-term survival. Thus The greater the network externalities of a product, the longer is the survival duration of the product pioneer.

Network effects become significant after a certain subscription percentage has been achieved, called critical mass. At the critical mass point, the value obtained from the good or service is greater than or equal to the price paid for the good or service. As the value of the good is determined by the user base, this implies that after a certain number of people have subscribed to the service or purchased the good, additional people will subscribe to the service or purchase the good due to the value exceeding the price.

A key business concern must then be how to attract users prior to reaching critical mass. One way is to rely on extrinsic motivation, such as a payment, a fee waiver, or a request for friends to sign up. A more natural strategy is to build a system that has enough value without network effects, at least to early adopters. Then, as the number of users increases, the system becomes even more valuable and is able to attract a wider user base.

Beyond critical mass, the increasing number of subscribers generally cannot continue indefinitely. After a certain point, most networks become either congested or saturated, stopping future uptake. Congestion occurs due to overuse. The applicable analogy is that of a telephone network. While the number of users is below the congestion point, each additional user adds additional value to every other customer. However, at some point the addition of an extra user exceeds the capacity of the existing system. After this point, each additional user decreases the value obtained by every other user. In practical terms, each additional user increases the total system load, leading to busy signals, the inability to get a dial tone, and poor customer support. The next critical point is where the value obtained again equals the price paid. The network will cease to grow at this point, and the system must be enlarged. The congestion point may be larger than the market size. New Peer-to-peer technological models may always defy congestion. Peer-to-peer systems, or "P2P," are networks designed to distribute load among their user pool. This theoretically allows true P2P networks to scale indefinitely. The P2P based telephony service Skype benefits greatly from this effect (though market saturation will still occur).

Network effects are commonly mistaken for economies of scale, which result from business size rather than interoperability. To help clarify the distinction, people speak of demand side vs. supply side economies of scale. Classical economies of scale are on the production side, while network effects arise on the demand side. Network effects are also mistaken for economies of scope.

The network effect has a lot of similarities with the description of phenomenon in reinforcing positive feedback loops described in system dynamics. System dynamics could be used as a modelling method to describe phenomena such as word of mouth and Bass model of marketing.

Network effect is a benefit to society as a whole because it positively relates to and affects the Intellectual Commons, Property Rights, and Cultural Commons of the world. One form of network externality is social media, which is a peer-to-peer network ran by a privately held for profit business. Although the creation of a large network creates a barrier to entry according to Porters five forces and may prevent a few from creating a new form of P2P networking, it largely benefits society as whole and provides a new form of a common-pool resource solargely scalable that the entire world has the ability to use it. Although the barrier to entry may be high, there is no true form of monopoly in the P2P social sharing market. For example, Facebook holds a large stake in the P2P social sharing market, but it is not mutually exclusive, meaning users can have an account on Facebook and also have an account on Twitter. Furthermore, there becomes no true critical mass in this space due to the ability for technology and innovation to constantly adapt to different environments, market for underdeveloped countries to integrate with social sharing is unlimited.

Network effect relates to the intellectual commons in a positive way. Through P2P networks users are able to share their intellectual property in a way that can benefit society as a whole.The sharing of intellectual property ultimately relates to, economic growth due to the ability for creators to share information and still possibly benefit financially from it. Through P2P networks people are able to share types of education like scholarly articles, becoming a new form of public commons. Network externality like Ted.com is an example of how intellectual commons with the use of network externality benefits society as a whole. Those who present intellectual property at Ted conferences are sharing their education on a public forum that benefits whoever will listen. Therefore, the larger Ted.com network becomes positively correlates to those who benefit from its common-pool resources.

P2P networks positively affect property rights. In reference to property rights, it enables those who create the intellectual property: The right to use the good, The right to earn income from the good, The right to transfer the good to others, The right to enforcement of property rights. Through P2P networks those who provide intellectual property not only have these rights, but they also possess the right to claim their information on a public forum. Due to these rights sharing benefits the intellectual property holders and promotes P2P sharing in a positive way. Those who consume the intellectual property also benefit positively from the sharing of it because they are able to use the information freely with respect to the person who created it. An example of this system in effect is a company called Music Vault. Music Vault operates on the P2P network Facebook, enabling users who create music to openly and freely collaborate with other artists content. This is a form of remixing that benefits both parties. This is an example of how a P2P network positively affects the sharing of property rights. In Joseph E. Stiglitz essay Prizes, Not Patents, he suggests that the creation of intellectual property should be rewarded with by social gratification and rewards instead of patents preventing others from duplicating the creation and sharing it as a common-pool resource. This can be related to P2P networking because it creates a greater incentive for those who create intellectual property to share it is a common-pool resource. As a P2P sharing network becomes larger the gratification of being rewarded on a global public forum would compete with a patent. It is through large P2P networks and network externality that humans can create a reward system large enough to deter seekers of patents to be rewarded in different ways.

Network Externality positively affects the cultural commons in many ways. The reward for being part of a group, society, and even the world through a P2P network is one of the greatest benefits that a modern common-pool resource can provide.The ability to connect and create with people from different cultures, ethnicities, and beliefs is something thought to be impossible 100 years ago. Without network externality this form of communication would have been impossible. Through P2P sharing the world as a culture are able to learn and teach each other through public forums. In Sugata Mitra’s Ted talk, “The child-driven education” he placed a computer in the a third world town and left it there to see what would happen. To his amazement children were able to quickly figure out how to use the computer and educate themselves on its inner workings. This example is a benefit to society for several reasons. The first is the relationship between Sugata Mitra and the P2P network which led him to place the computer in a third world town, along with the ability to present his findings on a public forum. Secondly, it is those who consumed his ted talk and benefited from the knowledge that those in third world countries just need a chance to learn and they will take it. This experiment as a whole brings the culture of the world together and connects us with those we thought impossible due to the P2P network and network externality that led individuals to the Ted talk.

A great example of this is the grocery delivery business WebVan. The real issue here was that they needed scale (as all groceries do), and spend a fortune on this before they knew their market or their chances of success. The fact is that the revenue that was coming in ...