1. 1
CH 9 e-ECONOMY: e-Products
and e-Marketplaces
 e-commerce is already having a
noticeable impact upon market
structure and the behavior of
business

2. 2
 ‘Anyone who fails to become an e-
business will become an ex-business’
(Phil Lawler, MD of Hewlett-Packard)
 ‘In 5 years time, all companies will be
Internet companies, or they won’t be
companies at all’
(Andy Grove, Chairman of Intel)
The Hype!!

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What kind of things we study
in e-economics:
 e-products
 e-marketplaces
 impact of e-economy on market
structure, business and consumers

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e-Products
 An e-product:
 can be digitally encoded then
transmitted rapidly, accurately
and cheaply
 e.g. music, films, books, sport …
 Fixed costs of producing e-
products are huge …
 … but marginal costs of distribution
are tiny
 implying vast economies of scale

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Consuming Information
 experience
 overload
 switching costs
 network externalities
Four key features of e-products:

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Experience Products
 An experience good or service is
one that must be sampled before
the user knows its value
 information is nearly always new
 marketing needs careful attention
 free samples
 previews
 establishing reputation

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Information Overload
 … arises when the volume of
available information is large
 …but the cost of processing it is
high
 screening devices become crucial
 search engines and shopping
bots

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Switching Costs
 … arise when existing costs are sunk
 for example, changing supplier incurs
additional costs
 smart suppliers use strategies for
locking in their customers
 e.g. air miles, supermarket reward
cards

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Beneficial Network Externalities
 Many information goods are also
characterized by network externalities:
the value of the good to an individual is
greater when a large number of people
also use the good (e.g. fax machines,
Internet, e-mail)
 Note that congested trains or roads are
unattractive networks. Externalities are
not always positive. However, the first
fax machine was invented over a
hundred years ago, yet they did not
become popular till everyone believed
everyone else would have one

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 Network externalities explain why
there is a sudden switch to a new
system when public opinion
suddenly has confidence in the
new network
 Network externalities cause
positive feedback, in which either
initial success or initial failure is
self-reinforcing: success breeds
success, failure breeds failure

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Critical Mass and Industry Takeoffs
 When network externalities are strong,
a large proportion of consumers may
not be willing to purchase a good
unless the number of existing users
exceeds a threshold network size
 This leads to the critical mass effect, a
sudden rapid increase in the network
size
 Networks with more users are more
valuable to belong to ⇒ networks may
therefore subsidize new membership

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Network Externality:
Threshold Network Size

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Critical Mass
Critical mass effects change the quantity
demanded over time of a good with network
externalities. The quantity demanded grows
slowly until critical mass is reached; once
reached the quantity demanded suddenly
explodes.

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Network Externalities
Suppose D1 represents the demand curve for a
product exhibiting network externalities
€
Quantity
D1
P1
Q1
With price at P1, quantity demand is limited.
If price is reduced to P2, more
people find the network attractive
so not only is there a move along
the demand curve, but there is
also a shift in demand.
P2
D2
Q2
Long-run demand is more
elastic (D).D

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Case: Apple’s Big Mistake
Even though Apple’s computers were
clearly technologically superior to the
alternatives well into the 1990s
(devotees say they still are), they have
always remained a small part of the
market .
Apple failed to recognize the strength of
the network externalities that caused
many users to stick with an inferior
product that was widely used, especially
given the fact that the superior
alternative was considerably more
expensive.

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Pricing of Information Products
 Most workers are employed in the
production of conventional goods and
services: cars, houses, haircuts, and
so on
 But considerable resources are now
also devoted to producing information
goods—products whose value comes
not from their physical characteristics
but from the information they embody

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Information: the supply side
 Given substantial economies of scale,
we expect monopoly suppliers of
information products1
:
 Dominant firm with competitive
fringe
 e.g. Microsoft
 Niche market monopolies
1
industrial economy was made up largely
of oligopolies limited by their existing
capacity

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 Efficiency requires that goods sell at
their marginal cost, and information
goods have low marginal cost
 However, because they have high
fixed cost, they won't be created
unless the producer can cover its cost
of production by charging a price well
above marginal cost
 But like monopoly, this leads to an
inefficiently low quantity of output

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 A musical recording has
high fixed cost and low
marginal cost, a situation
similar to natural monopoly
 The profit-maximizing
price, PM, is $5, the
average total cost, ATCM, is
$3, resulting in a per-unit
profit of $2
Assumptions: FC = $1.5 million, MC = 0
The Profit-Maximizing Quantity
of an Information Good

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Pricing Problems for Information
Goods

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The Problem of Achieving Efficiency
with an Information Good
• The profit-maximizing
music company behaves
like a monopolist
• Offering the good for free
leads to a gain in total
surplus of area E
• However, if forced to
provide the good for free,
the music company is
likely to forgo producing
the good altogether

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 Monopoly is a bad thing, other things
equal; it is inefficient to charge a price
that is above marginal cost. But the
expectation of monopoly profits is
necessary to induce the company to
produce the good at all. Indeed,
economists generally agree that when
it comes to information goods, a
temporary monopoly may be the
necessary price of progress
 Why temporary? As we will see, both
law and natural forces tend to limit the
duration of the monopolies associated
with information goods

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Property Rights in Information
 A patent gives an inventor a temporary
monopoly in the use or sale of an
invention; a copyright similarly gives
the creator of a literary or artistic work
sole rights to profit from that work
 By creating temporary monopolies,
patents and copyrights facilitate the
production of some information goods
 When this legal protection is not
available, producers of information
goods often manage to establish
temporary monopolies by exploiting
first-mover advantages

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Public Policy towards Information
Goods
 Antitrust policy
 Only monopolization -- efforts to
create monopolies -- forbidden
 What is the dividing line between
legal and illegal actions?
 Setting standards
 Need for common standards
creates a justification for
government intervention in the
economy

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Some strategies for pricing
information products:
 Two-part tariff
 an annual charge to cover fixed
costs, and a small price per unit
related to marginal costs
 Versioning
 the deliberate creation of different
qualities to facilitate price
discrimination
 Bundling
 the joint supply of more than one
product to reduce the need for price
discrimination

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Competition vs. Collaboration
 A strategic alliance is a blend of co-
operation and competition, in which a
group of suppliers provide a range of
products that partly complement one
another
 e.g. Microsoft and Intel
 airline alliances: One World, Star
Alliance etc.

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What's
the attraction?
e-Marketplaces
 B2C, C2B, C2C, and B2B
 eMarketplaces differ widely in both
their complexity and objectives
 Their principal aim, however, is to
bring buyers and sellers together:
 aggregation and matching
 How might such marketplaces
achieve these goals?
 improved computational and
communication capability due to
improved ICT

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eMarkets Evolution
EDI
1 - N
<1999
Internet
M - N
1999 – 2001
eMarkets
2000–2004
eMarkets
SC Integration
2001–2006

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One BuyerOne Seller
Negotiation
Many Buyers
Auction
Many Sellers
Reverse
Auction
Exchange
or
Markets
Market Framework

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 Business introductions
 Many e-marketplaces, such as
lotsofplastics.com, acts simply as an
electronic notice board, bringing together
buyers and sellers. Once they have found
each other the transaction process is
negotiated and settled off-line
 On-line catalogues
 A more sophisticated e-marketplace is
where a seller places on-line their
catalogue, detailing products, price
availability and delivery. Buyers can then
browse, place orders electronically and on
certain sites make payments on-line

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 On-line or e-auctions
Just as in a normal auction
process, only in this case within
an e-market, the seller puts up for
sale a given product or service
and invites offers
 eBay and uBid
 Goindustry.com, a European
e-marketplace for selling used
and surplus machinery

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 e-exchanges
 Like a stock exchange, it matches
buyers and sellers via a bid and
offer price system
 The reverse auction/procurement
in e-marketplace
 Here a buyer puts out a tender
and invites suppliers to put in bids

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 Originally it was thought that e-auctions
are most suitable for products or
services that are relatively basic
 in which price is the most important
determinant of sale
BUT
 non-price factors, such as the product’s
quality, terms of delivery, warranty,
reliability or after-sales service are
often at least as important as the price
 More recent auction systems, however,
can now handle also multi-issue
auctions

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 Other services. As well as buying and
selling, a number of e-marketplaces
are aspiring to greater things
 Many currently provide an industry
news service. Some are seeking to
establish greater collaborative working
between industry members, in for
example areas such as demand
forecasting and logistics

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Who Gains What in an e-Marketplace?
 Perfect competition
globalization
prices become more transparent
competition gets harder
lower prices
 or more segmented markets?
firms seeking monopoly power
through product differentiation
increased customer information
 cookies etc.
tailored products
 increased price discrimination

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The Gains for Buyers
 essentially based on the significant
reduction in transaction costs
 bidding or auction process likely to
drive product or service prices down
 buyers will be put into contact, not
only with a wider number of suppliers
but, with new suppliers as well
 easy and direct access to new
sources of supply will reduce the
need to carry stocks

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The Gains for Sellers
 access to new buyers and so
potentially increased sales volume
 as with the buyer, the seller is
likely to experience significant
reductions in transaction costs on
each sale made

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Gains for consumers from B2B
 As procurement costs are cut, the
costs of producing goods and
services should fall
Some of these cost savings should be
passed on to the consumers in lower
prices

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Gains for the Economy:
New Economy?
 Increased productivity in the network
economy
 IT contributes approximately 50 per
cent to GDP growth
 It is anticipated that this will rise with
the increase of e-business
 Goldman Sachs estimates that the
effect of B2B on aggregate supply
(AS) will increase average growth
rates by 0.25 per cent for the next 10
years

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Gains for the Economy: New
Economy?
 Increased productivity shifts the
aggregate supply to right
A
S
AD
National output, Y
Inflation, % National output will
increase,
unemployment
decrease AND
inflation rate can
stay relatively low
AS’

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Long Cycles
Kontratiev, Schumpeter
1 cycle 1790 - 1844 Steam engine
2 cycle 1844 - 1895 Railroads
3 cycle 1895 - 1946 Electricity and
motor
vehicles
4 cycle 1946 - 1990 Cheap energy
5 cycle 1990 - Information
technology

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Understanding the e-Economy
1 The information revolution is
changing our lives
 but few of its activities or market
tactics are unprecedented
2 The revolution in technology has
not required a corresponding
revolution in economic theory