Fifth International World Wide Web ConferenceMay 6-10, 1996, Paris, France
Fifth International World Wide Web Conference
The World Wide Web has literally burst upon the businesses in recent times. With the Web doubling in size every 53 days or so, the growth is biological. With a technology as recent and fast proliferating as this one, paradigms often lag behind action, and the hype. Still, paradigms alone provide an objective coasting course through turbulent waters. Two paradigms which are thought to be helpful in formulating a strategy for doing business on the Internet are the value chain analysis and transaction cost economics. Value chain analysis helps businesses identify specific areas where the Internet can add value and the transaction cost analysis provides a basis for why value is added as transactions move across boundaries in value chains. In this paper we employ these twin analyses and propose a framework for strategic planning to develop business opportunities in the new arena of the Internet. This is expected to provide a basis for further analysis of Web-based business. Some examples from the real world help put this twin analysis in perspective. Key words Web-based Business, Strategic Planning, Competitive Advantage, Value Chain Analysis, Transaction Cost Economics, Value of Information, Extended Enterprise.
The advent of the Internet as a viable business tool is likely to have the same impact on businesses and their information systems as the spread of personal computers during the early 1980s. The literature falls short of discussion of two important aspects of this technology: strategies and economics of doing business on the Internet. Amid the myriad of practices, lessons, and anecdotes, there is a clear need for developing an understanding of the commonalty as well as the uniqueness of Web-based business with respect to the traditional general business. In particular, it is important to know whether or not the strategic planning methods of general business still apply to this new branch of business, and if so, how?
Striving towards answering this question, we mainly delve into two classic representative paradigms, viz., value chain analysis and transaction cost economics, and our previous research on Strategic Information Systems[6, 11] and the Value of Information [5] to come up with a strategy formulating framework for doing business on the Internet. We first analyze and apply these paradigms to Internet-based business in the next two sections and then present the planning framework in Section 6 with examples.
2. From Strategic Thinking to Strategic Planning
Even before the businesses realized the potentials of the Web to attain competitive advantage, they realized the strategic importance of information systems and planning for such systems. Strategic Information Systems Planning (SISP), is the analysis of a corporation's information and processes using business information models together with the evaluation of risk, current needs and requirements. The result is an action plan showing the desired course of events necessary to align information use and needs with the strategic direction of the company [1]. Some characteristics of strategic IS planning which help in providing a framework for doing business on the Web are:
3. Two Frameworks for Strategic Systems Planning
Vitale, et al. [16] classify SISP methodologies into two categories: impact and alignment. Impact methodologies help create and justify new uses of IT, while the methodologies in the "alignment" category align IS objectives with organizational goals. These two views of SISP are shown in figure 1.
Which perspective of planning for Internet connection for an organization and doing business over the Web will be used will depend on the proposed use for the Internet/WWW in the business. If the Internet is used merely for e-mail/Usenet or even intra-firm connectivity, the alignment perspective will apply. However, if the Web is used as an alternative medium for doing business -- reaching out to customers, suppliers and vendors, creating virtual organizations and teams, transacting actual commerce including financial transactions, then the impact view will prevail. And this is what doing business on the Web is mostly about -- an electronic alternative to the real marketplace, which is not only viable, but is also far more efficient, cuts across geographical boundaries and time zones, is growing at an unprecedented rate, has low entry barriers, is innovating fast, and to confound matters further, relies on different business paradigms. This is what the media attention is all about ; the Boston Globe reported over three thousand articles in the press about Internet in nine months in 1995 [2] and this is where the emerging visions of Electronic Data Interchange (EDI), Virtual Corporations (VC), and the National Information Infrastructure (NII) (Information Superhighway), etc., have their roots.
4. Value Chain -- A Framework For Internet Strategy Formulation
The value chain analysis is a powerful tool used by strategists to diagnose and enhance competitive advantage. Value chain analysis allows the managers to separate the underlying activitiesa firm performs in designing, producing, marketing and distributing its product or service. It is these activities from which competitive advantage ultimately stems. By showing how all the firms activities can be examined in this integrated way, Porter [13] provided an original, practical perspective of competitive advantage.
Value Chain Analysis provides an appropriate framework for planning Web based businesses because it deals with the value added (and not merely cost saving) aspect of a system and thus helps in assessing the impact of an information technology on the business. The concept of value chain is to treat every firm as a collection of activities that are performed to design, produce, market, deliver, and support its product with information technology being one major support activity for the value chain. Information systems technology is particularly pervasive in the value chain, since every value activity creates and uses information and therefore can substantially affect competitive advantage of firms. A firm that can discover a better technology for performing an activity than its competitors gains competitive advantage [13]. A typical value chain is summarized in the figure 2.
Thus, essentially, value chain analysis is a form of business activity analysis which decomposes an enterprise into its parts and helps in adopting a technology which increase the overall profit available to a firm. It also helps in identifying the potential for mutual business advantages of component businesses, in the same or related industries which is available from information interchange. Value chain analysis concentrates on value-adding business activities and is independent of organizational structure.
Internet positively affects all parts of the value chain of a firm. In respect of Primary Activities, namely, Inbound logistics, Operations, Outbound logistics, Marketing and sales and service noticeable impact of the Internet is as follows:
However, associated with the apparent low cost of marketing a product on the Web is the issue that a big chunk of the marketing cost is passed on to the consumer (it is s/he who buys the computer, modem, Internet connection, etc.). It is likely that as the technology matures and becomes widespread, a large number of consumers will have Internet connectivity through moderately priced, perhaps dedicated, Internet computers. When that happens, the cost function will be similar to that applied to TV and marketing channels on TV, where consumers invest in technology and services for their entertainment/educational value of the technology as well as the convenience of shopping from home.
Thus, a detailed value chain analysis as outlined above will help a firm in formulating its Web-based business strategy in many important ways:
We need an economic model to complete the analysis carried out in the above sections. Transaction cost analysis provides a viable economic frame work for understanding the business on the Web.
Transaction Cost Economics
Transaction Cost Economics owes its origin to Ronald Coase [3] and was further developed by Oliver Williamson [19]. A key concept in production is the firm. A firm is an economic institution that transforms factors of production into consumer goods. A firm (a) organizes factors of production, (b) produces goods, and/or (c) sells produced goods to individuals.
The firm operates within a market, but simultaneously, it is a negation of the market in the sense that it replaces the market with command and control. How an economy operates--which activities are organized through markets, and which activities are organized through firms--depends upon transaction costs--costs of undertaking trades through the market--and the rent or command over resources that organizers can appropriate to themselves by organizing production in a certain way.
Markets, on their part, reduce the cost of exchanges (transaction costs) as people dealing through market mechanisms do not need to negotiate and enforce individual contracts as well as do not need to acquire and process information about alternatives.
Generally, the less organized the market, the higher the transaction costs. Historically, the less costly it has become to disseminate information through technological improvements, the more transaction costs have fallen.
Transaction Cost Economics moves away from the simplistic assumption of classical economics that exchange mechanisms taking place through the price mechanism are homogeneous. In actuality additional transactions take place outside simplistic price mechanisms in our complex modern world, and they all entail a cost. These "non-price" costs, transaction costs, are treated as basic unit of analysis in Transaction Cost Economics.
As opposed to the costs of producing real products, transaction costs are the costs of organizing economic activity. These costs come from four major sources, the first two arising from a characteristic of human nature while the other two from environmental factors. Web based business helps in reducing all of the four types of transaction costs.
1. Bounded Rationality. Human beings have a limited capacity to receive, store and process information. Because of this limitation, an uncertainty is introduced in the decision making process even though all the data needed for a rational decision making is theoretically available. This uncertainty is different from and is in addition to the market uncertainty.
2. Opportunism. This is a type of behavior in which individuals attempt to realize gains "through a lack of candor or honesty in transactions"[18] and seek self interest. More generally, opportunism refers to the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse [19, p.47].
3. Market Uncertainty. This refers to the unpredictable change of price, quality, supply, or demand for the intermediate product. Uncertainty arises from random acts of nature, unpredictable changes in consumer preferences and lack of communication [19, p.57].
4. Asset Specificity. Transaction costs due to asset specificity arise when traders' options for transferring their businesses to alternative suppliers or buyers are limited. This happens in the common situation where parties are engaged in trade that is supported by non-trivial investments in transaction specific assets. Characteristics of asset specificity are:
From the perspective of Information Technology, transaction costs are the costs of all the information processing necessary to coordinate the work of people and machines that perform the primary processes, like determining the design, price, quality, delivery schedule and similar factors for products transferred between adjacent steps in a value chain. Purpose of Information Technology is to bring down transaction costs and that is the criterion against which we will evaluate the business use of the Web.
Transaction Costs and Business on the Web
Bounded Rationality: The World Wide Web, or for that matter any other technology, can do little to improve or supplant human thinking or information processing capacity. All the promises of AI based "smart machines" which were at one time thought to greatly parallel human thinking haven't yet materialized. What modern computers have however done is: (a) due to their increased data processing capacity, they have helped in producing information faster and cheaper and (b) the Internet, arising out of its near zero marginal cost of providing information to an additional user, has produced a great Information surplus, the proverbial "information overload".
Despite this limitation of the technology, it has the potential to reduce transaction costs due to bounded rationality in two ways: (i) by providing search engines, the older ones like Veronica, Archie, WAIS and the newer ones like Yahoo!, Lycos, OpenText, etc. These search engines have the potential to provide the right and timely information to decision makers, although the real technology still has quite a way to go towards making information retrieval quick and easy (ii) secondly, and this is where the real power of Internet might lie, the Internet opens all echelons of management, indeed the entire organization, to vast information resources. Therefore, more and more heads in the organization get involved into processing information. Thus, although individual information processing capacity doesn't go up, the collective information processing capacity of the organization increases. Reaping benefits of this aspect of bringing an organization on Internet, will however require some fundamental changes in organizational culture and thinking. A parallel to this culture is the quality circle concept used successfully in Japanese manufacturing firms.
Another important benefit which can accrue from bringing Internet to an entire organization is that traditionally overworked and time-constrained top management have been responsible for scanning the external environment for new product/service idea to support/formulate strategy for the organization. In Internet linked companies, practically the whole organization can perform (or atleast assist in) this process by participating in forums like Usenet and visiting interesting home pages. Obviously such a firm wide participation requires an open and trusting management style as well as a careful, Internet training program.
Opportunism: The Web reduces transaction costs associated with opportunism in an interesting manner: not by altering the human nature (which, probably is the job of priests!) but by reducing information impactedness. And this has to do with the nature of the Internet, and not human nature.
The entire culture of Internet has been open, collaborative and non-hierarchical. This is quite the antithesis of opportunism. Infact doing business on the Internet changes the business in major ways. In their recent article, Benjamin and Wigand[2] have demonstrated how doing business on the Internet can reduce profits in the value chain and reduce the cost to the customer. This, obviously, would result in a smaller pie for the industry which goes on the Web. However, because of the reduced costs to customers, the number of pies would increase and the overall profitability will most likely remain unchanged, if not go up.
It might well be that the Internet will help businesses move towards the ideal of perfect competition with the buyers and sellers having complete and ready information about one another, as was envisaged by Adam Smith in his classic Wealth of Nations [15]. In the long run Web-based business will be good for the economy because as a rule an innovation that cuts costs and raises productivity will tend to raise economic well-being and create new industries and opportunities.
The definition of opportunism, that "...opportunism refers to the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse" very aptly applies to modern day advertising. And the modern day advertising as well as the media which carry them, especially the TV, have been criticized for their unhealthy effects on consumers. If advertising on the Web is any indication of the role of advertising in future, a major source of opportunism will either disappear or atleast will be substantially curtailed. Basic reasons for this are in the nature and culture of the Internet itself as well as in the interactive nature of this medium. Also, consumers have more time and space than the traditional 30 seconds on TV or 10 lines (and fine print) in the newsmedia to evaluate a product. Advertising on the Web is more in the nature of informing the customers by way of making substantial data and "white papers" available to them. Then there is the power of the Usenet where products, services and software are discussed and evaluated with free abandon. One case in point is the careful evaluation of travel agents providing air-tickets to travel to India. These travel agents are constantly evaluated by regular feedback from users and their responses are archived and made publicly available on the Internet. Consequently, a travel agent now requires to be "net certified" before her/his services are bought.
Market Uncertainty: Some of the arguments given in the section on bounded rationality apply here also. Also, because of certain unique marketing functions performed by the Internet, market uncertainty can be reduced more from the data collected by the Web pages maintained by a business than by other traditional means like market research.
The Web affords the provision of marketing information which was not otherwise available. Analysis of the log files for the Web server access show which pages are being browsed by visitors. As stated elsewhere, it is now possible to see what consumers who do not make a purchase look at. This can provide timely and unique market intelligence. Also, on-line surveys can help in collecting users responses and provide useful demographic data. Infact for a number of high activity sites, the only "price" which a visitor pays is in terms of time in filling out an on-line subscription form. Honda's slick web site [http://www.honda.com/] provides a "design your own car" option which is nothing but a way of collecting customer data and preferences in disguise.
Asset Speicificity: The Web can help in reducing transaction costs associates with asset specificity arising out of both, a specific investment in capital and firm specific human capital. The Web changes the modes of doing business from intensely competitive to collaborative. For example, firms which get involved in electronic commerce, view their vendors and suppliers more as collaborators who have similar information systems to facilitate EDI and electronic commerce. Thus firms tend to move from a large number of suppliers to a smaller number, losing some of their bargaining power in terms of price of raw material etc. to gain greater standardization of information technology. This standardization across an industry and increased collaboration between firms will help reduce transaction costs due to asset specificity.
Another way in which the Web can help in reducing asset specific transaction costs is by greatly facilitating formation of virtual organizations and teams, which are put together for the purpose of carrying out a very specific project. A case of such virtual teams getting involved in a major automobile project is reported in Rayport and Svikola[Rayport and Svikola, 1995]. Ford's "global car", Contour sedan, was developed by virtual work teams formed around the world. Such an effort not only extracts the best talent and the broadest vision, but also reduces asset specificity as investment in some asset specific capital, human or otherwise, is easily shared across a firm, across industry, and between industry and research/academic institutions.
Free and ready access to a great amount of software and code available on the Internet is another example of reduction of asset specific transaction costs. Software developed by firms, big and small, are regularly beta-tested by users over the Internet as well as large amounts of publicly available code are regularly used by programmers and developers. The quality of such "shareware" is very high, because the software is so widely distributed through the Internet, any bugs or glitches are reported and fixed right away by the user community. The improvement cycle is much faster than with most because there is a tendency to share enhancements freely[Cronin, Mary, 1995].
Still another example of reduction of transaction costs due to asset specificity is the ingenious use of the Web by the digital [http://www.digital.com/] to provide an open testing area for its customers and others to test drive systems. An arrangement like this where customers can test drive a highly asset specific product like a computer hardware or software would greatly reduce transaction costs involved in meeting customer requirements otherwise.
An example of reduction of asset specific transaction costs, in which we have been directly involved for over one year, is our research group's Enterprise Integration and Modeling Home Page [http://viu.eng.rpi.edu/]. This home page describes nearly a decade long research efforts of our group. The research group has developed a CASE-tool which is distributed free from its web pages. Ever since the creation of the home page in October 1994, it gets around 150 hits per day. This page has been accessed from over 40 countries world wide. Many persons in educational, research and commercial organizations have downloaded the CASE-tool from our web pages and some professors are using it as a part of their course work. We provide all the directions for downloading and installing this very "asset specific" product as well as user education through on-line documentation and FAQs. Our experience has been that not only users around the world have successfully learnt to use this software and the fairly involved methodology behind the software, but have also contributed towards (a) helping us find and fix bugs and (b) raise thought provoking questions about the underlying methodology which has helped us refine some concepts and philosophical questions concerning the methodology. Without the Internet and the Web, similar results would have been probably possible only by extremely costly demonstrations of the software at international conferences/seminars, exchange of faxes and letters, and possibly, even scholars and researchers. We are now in the process of creating a virtual laboratory where students from different countries can form teams and develop models using the above CASE-tools, thereby bringing country specific business aspects to their joint models. Transaction costs of such an endeavor without the Web would be prohibitive enough to render it well nigh impossible.
6. Planning for Strategic Goals: A New Integrated Framework
Full business potential of the Internet will present itself in a proactive review of this technology in light of yet developing competitive opportunities. The promise of dynamic alignment of this technology will serve to remove organizational constraints and allow extended enterprises to develop, thereby opening up new, fundamental, strategic opportunities for enterprises. A new planning framework utilizing the above results is proposed here. It combines top-down (businessgoal-driven SISP) with bottom-up analysis (IT-driven strategic planning) into a set of guidelines for Web-based businesses. A key concept is to integrate Web applications with an enterprise's traditional applications over the networks. The new framework undeelying these guidelines is illustrated in figure 3. The guidelines constitute the connections shown in the figure to generate strategic uses of Web-based technology for new enterprises
Managing External Environments. The following heuristics focus on the direct, external application of the Internet on the market as a strategic weapon to gain competitive advantages. The principle is to manage uncertainty in the enterprise environment.
1. Provide Information Services to Customers. The idea is to lure and lock customers in to the enterprise by investing in Internet and Web-based business that provides unique and crucial services to them. The added value is in external orientation. Allowing customers to track their packages through an innovative use of their home page by FedEx [http://www.FedEx.com/], and facilities for online banking through the Web pages of the Wells Fargo Bank [http://www.wellsfargo.com/ ] are two such Web-based applications. This use of the Internet has its parallel in classical cases of the use of then new technologies; the American Airline's Sabre system for travel agencies and Citibank's Automatic Teller Machine (ATM) for individual customers.
2. Turning Information Services into Products. We can extend the above notion of customer service to information products or information service profit centers. The Sabre system has become a major source of revenues for American Airlines since travel agencies pay significant fees for its extended services. In a similar way, proprietary information technology and services that an enterprise develops can be turned into dedicated information service providers or spin-offs in the market. Electronic commerce and global information enterprises seem to be especially ripe for this type of opportunity. Yahoo! [http://www.yahoo.com/] and similar Web search services like Lycos, OpenText, etc. are the examples of information services that have been turned into products on the Internet.
3. Monitor the Market and Customer Behaviors. Marketing databases have proven to be a potent weapon for gathering marketing intelligence and assisting in new product development. Their key is to exploit ubiquitous interfaces with customers (coupons, purchases, repairs, surveys, and the like) and turn them into intelligent information for strategic uses. A broader implementation of managing external environments would include not only the customer but also the supplier and other constituencies of the extended enterprise including external users of the Internet. Analyzing the information needs of these external users within the context of their respective enterprises and employing Internet to satisfy their needs will work to the organization's benefit. Basic strategic gains result when an organization is able to do more in the way of extended contact and use the feedback gained to improve internal and external business processes. The Web affords the provision of marketing information which was not otherwise available. Analysis of the log files for the Web server access show which pages are being browsed by visitors. It is possible now to see what consumers who do not make a purchase look at. Such information may change marketing research as fundamentally as did the mass of data generated by bar-coding[10].
Maximizing the Internal Networking of Processes and Resources. The second set of heuristics is oriented towards improving the production function of an enterprise, thereby enhancing its productivity (measured through cost and quality). Linkages will be created across an enterprise to connect all stages of cycles, including: differing levels of granularity (product, production, and part); flows (information vs. materials); and businesses (administration vs. production). By connecting all stages of the business cycle, maximum channels of communications can be created to minimize the internal uncertainties facing an enterprise, and resources can be pooled and utilized throughout the extended enterprise. Globally optimized performance can result. Intra-firm connectivity possible through the Internet is a case in point.
1. Employ and Deploy Internet to the Core Production Processes. A production system that delivers higher quality at lower cost than competitors is the most fundamental strategic advantage for any enterprise. The Internet, used for Lotus-Notes like intra-firm connectivity, can help in achieving this goal within manufacturing enterprises and many other operations-oriented enterprises (e.g., the mail and parcel delivery industry).
2. New strategic opportunities for Internet, in part, will arise from creating feedbacks to complete a cycle (part, production or product) and from connecting all cycles through forward and feedback linkages. Both forward and feedback set the stage for dynamic alignment in its fullest potential.
3. Connect Administration Systems with Production Systems. Information Technology has been historically applied to business administration functions of an enterprise first. Then, when it is also employed within production, the two sides are kept separate functions. Information Integration allows and asks that the walls separating administration from production come down, just as Information Technology bridges information flow with material flow. An interesting example showing the significance of this connection is activity-based costing and management, in which the classical administrative function of accounting is conducted on the basis of monitoring the alignments of resources around activities. This monitoring certainly can be and should be made on-line and in real time. Total Quality Management (TQM) is also based on performance information cutting across administration and production. Calibrating and aligning administration with production on an on-line, real time basis produces the ultimate decision-making information within an agile, lean, and productive enterprise. This provides another yardstick to gauge strategic use of the Internet.
Transforming into a Three-Dimensional Enterprise. The following three sets of heuristics provide some proactive guidelines for high-level Information Technology planning towards enterprise integration and modeling. They expand the scope of enterprise from the traditional view into both extended enterprises and information enterprises.
1. Think Extended Enterprise. All the discussions pertaining to the internal production systems and administration of an enterprise are applicable to the virtual systems of an extended enterprise. Strategic opportunities for streamlining operations across organizations to gain synergism and efficiency are practically unlimited. The fact that there are tremendous constraints and difficulties against fully applying Information Technology to an extended enterprise is also the reason for its tremendous significance. The health care industry is arguably the most fertile ground for this concept. The opportunities implicit in connecting insurers, hospitals, physicians, patients, government agencies, and research institutes through information integration is mind boggling. Other industries have, of course, similar opportunities. The Internet is a practical and inexpensive enabler of such integration.
2. Establish/Expand to Information Enterprises. Traditional business thinking focuses only on the material enterprises of products, resources, and the marketplace. Running parallel to the material enterprise is an equally large world of information enterprises in cyberspace that can utilize the same enterprise thinking. A virtual medical center, for example, could be constructed by using personal medical instruments located in patients' homes and linking them with doctors and researchers through multimedia telecommunication systems. A third-party information server/clearing house could provide pooled inventories and other resources to its client organizations through information integration in an extended enterprise manner. An Army/Defense logistics system could be integrated in cyberspace with visualization, simulation, and global information management capabilities. A studio-style virtual classroom could result from combining virtual laboratories, multimedia courseware, and the World Wide Web to enable distance learning. This kind of electronic commerce and global information enterprise; opportunities are often hidden just under one's nose. When planning these new information enterprises, one could retain familiar paradigms by only transforming the perspective.
Evaluate Information Technology on Micro-Economic Bases. Mundane applications of Information Technology are usually motivated by and justified on the basis of cost/expenditure savings. To move beyond this rationale and to look for strategic opportunities, the valuation criteria needs to be changed. An enterprise can evaluate Information Technology on three micro-economic criteria: transaction cost reduction, utility improvement (value/benefit added), and organizational design. In theory, the best representation of the role of Information Technology is its impact on the basic production function of the enterprise. One could formulate information to be the fourth basic factor of production in addition to labor, land, and capital. In reality, however, such a function is impractical for any enterprise. Thus, these criteria become useful surrogates for the production function theory. They may not be specific enough to quantify the value of Web-based business in operational terms, nonetheless they are sufficiently substantive to shed light on qualitative investigations for planning for such businesses.
7. Conclusion
The Web offers unprecedented and unique opportunities in supporting existing businesses as well as in transforming them. Since this technology is new, and evolving at a fast pace, as yet there are no stable models for understanding the business uses of the Web. We have applied two existing paradigms, the value chain analysis and the transaction cost economics as a means to understanding business uses of the Web and help businesses formulate their Web strategies. This paper is a small, but a significant step in understanding this phenomenon which is literally raging the business world. The issue of economics of the Web-based businesses is intimately related to the issue of information being a factor of production, and increasingly gaining prominence over other factors of production as computing costs go down, networks become wider and more stable and users become more computer friendly. In future we propose to fine tune our analysis with more rigorous treatment of the subject, probably with specific case studies and/or mathematical model building. We also expect to dwell deeper into the question of valuation of information and information systems.